Brad Setser

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China’s record demand for Treasuries (and all US assets) in 2008

by Brad Setser
February 23, 2009

This is Brad Setser once again. Thanks to both Rachel Ziemba and Paul Swartz for filling in for me last week. I rather enjoyed not having to write a post every day …

China has now released data on the PBoC’s other foreign assets (what I have called China’s hidden reserves) for December. The US TIC data for December is now out at as well. The two together permit us to paint a reasonably comprehensive picture of Chinese demand for US financial assets in 2008. This post updates the estimates of China’s true demand for US assets laid out in my paper with Arpana Pandey.* It consequently touches on the central subject of Geoff Dyer’s FT analysis piece, namely the scale of China’s holdings of US assets and China’s willingness to continue to add to its US portfolio.

Let’s start with China’s foreign portfolio. The PBoC’s other foreign assets didn’t fall in December. This means that the state banks’ required RMB reserves were reduced when the PBoC cut the reserve requirement then, not their required dollar reserves. It consequently is nearly certain that China has around $2.2 trillion in reserve-like assets — the $1.95 trillion in formal reserves, another $180b in “other foreign assets” (the foreign exchange the state banks have on deposit with the PBoC to meet a portion of their reserve requirement) and roughly $90b at the CIC (this excludes the funds the CIC has injected into state banks). The first three lines of the following graph consequently are pretty certain. The fourth line — which tries to estimate the foreign exchange held by the state banks — less so. I estimate that the state banks have around $200 billion in foreign assets, which brings the total foreign assets of China’s government to around $2.4 trillion. But I would be the first to concede that my estimate for the state banks’ foreign holdings is a more or less a true estimate — not a number that can be dug out of Chinese data if you know where to look.

There is no doubt that substantial sums of foreign exchange were shifted to the state banks through the use of swaps (in 06) and various recapitalization schemes (BoC and CCB in 2003, ICBC in 2005, CDB in 2007 and now ABC). There also is little doubt that the state banks are increasingly using that pool of funds to finance Chinese state firms “going forth” rather than to buy US bonds. The state banks almost certainly got burned on the US bonds that they bought in 2006. The only real question is the scale of their remaining holdings, and what the state banks have done with the funds that are no longer invested in foreign securities. My estimates for the state banks’ foreign portfolio is based on data the PBoC releases on the state banks foreign currency balance sheet, but I am not fully confident that my methodology really works.

On one point though there should be no doubt: China’s government is no longer adding to its foreign assets at quite the pace it once was. Something clearly changed in q4 2008. The growth in China’s foreign assets slowed even as China’s trade and current account soared. The most likely explanation is a rise in speculative capital outflows.

The slowdown in the growth in China’s foreign assets hasn’t yet translated into a slowdown in growth in China’s (estimated) US portfolio.

The data used to produce the previous graph can be used to plot the 12m change in China’s US holdings — and to compare the growth in China’s holdings to the valuation-adjusted change in China’s foreign assets. As one would expect, record reserve growth over the course of 2008 translated into record purchases of US assets.

China’s government provided — best that I can tell — close to $500 billion of financing to the US in 2008. That is a stunning sum. It should go without saying that I — like many in China — believe China now has more exposure to the US than is in its long-run interest. I also believe that the US relies far more on a single government for financing than is in its long-run interest. Both parties consequently should have an interest in moving — gradually — to world where China provides less ongoing financing to the US. In the interim, though, China’s exposure to the US is likely to be an ongoing source of friction. As Geoff Dyer reports, China now seems to want some influence over US macroeconomic policies — something the US historically has resisted.

An estimated $330 billion of the estimated $490b increase in China’s foreign assets went into Treasuries. And over the past three months, almost all the growth in China’s Treasury portfolio has come from its rapidly growing holdings of short-term bills not from purchases of longer-term notes. Fang Shangpu, a deputy director of SAFE, recently told a news conference (as translated by Andrew Batson of the Wall Street Journal):

Since the sub-prime crisis evolved into the international financial crisis in September last year, we have executed the central authorities’ plans to cope with the international financial crisis and launched the emergency response mechanism. We have closely followed developments, made timely adjustments to risk management, taken decisive and forward-looking measures to evaluate and remove risks …

In practical terms, China’s efforts to “evaluate and remove risk” meant selling financial assets with a bit of credit risk and buying Treasuries. It is an open secret that China is one of the big institutional accounts who have recently lost interest in Agency bonds.

The December TIC data suggests that China’s purchases of Treasuries — not just Chinese purchases of Agencies — is starting to slow. That is too be expected; the slowdown in China’s reserve growth should lead to reduced Chinese government purchases of US assets. And private Chinese purchases financed by hot money outflows wouldn’t show up in the US data at all.

The recent dynamics show up clearly in a plot that compares China’s estimated foreign asset growth (using the average of the last three months), China estimated purchases of US treasuries (also using a rolling 3m average) and its estimated purchases of all fairly safe US assets (Agencies as well as Treasuries). The three month average (and the three month sum) of China’s Agency and Treasury purchases historically has tracked China’s estimated reserve growth fairly well.** Recently though China’s purchases of Treasuries topped its reserve growth. That is only possible if China was reallocating its portfolio toward the safest asset around.

What about 2009? Well, if China’s reserve growth remains subdued because of ongoing “hot” or “speculative” outflows, China’s purchases necessarily will fall off their 2008 pace. Once China’s shift from Agencies to Treasuries ends, its Treasury purchases will also slow.

Yet so long as China’s current account surplus continues to grow (as imports fall faster than exports), China will necessarily be adding to its foreign assets and financing a deficit elsewhere in the world. If hot outflows continue, private outflows will just substitute for the growth in the portfolio of China’s government. And, well, tracking those private flows is a lot harder than tracking government flows.

After four years, I am reasonably confident that I know where to look to find the traces SAFE leaves in the US TIC data. But I have no idea how to track how the global banking system uses an increase in the offshore dollar deposits of Chinese residents.

* The core insight of the paper is simple: the pattern of past data revisions suggests that some of the purchases of US Treasury and Agency bonds attributed to UK and Hong Kong in the TIC data really should be attributed to China.
** I am quite proud of the close match between the two series. Remember that I am estimating the currency composition of China’s reserves as well as using the TIC data to estimate China’s pattern of US purchases. The fact that both estimates match reasonably well increased my confidence in both estimates. The estimates incidentally are based on entirely different data sets. The data on China’s foreign assets is derived entirely from Chinese data sources, together with an estimate of the dollar share of China’s portfolio. The estimates for China’s US purchases come entirely from the US data. The US data does influence my estimate for the dollar share of China’s reserves — which is a key input into estimating the impact of currency moves on China’s reported asset growth. But otherwise the two data sets are derived independently.


  • Posted by Twofish

    One interesting point is that CIC indirectly owns part of what is left of Lehman Brothers. CIC owns a part of China Development Bank that owns Barclay’s which owns Lehman’s North American operations.

    A more interesting question is whether China still wants to “go global” with its banks and whether the US will allow Chinese banks to set up operations in the US. If China wants to “go global” this not only means having capital available from its domestic banks, but also setting up branches of Chinese banks in overseas markets. If China starts doing major investments in the United States, then those investors will want to bank with BOC, CCB, ICBC, or CDB and that would involve major expansion of Chinese banks into the US.

    I can’t imagine the US allowing China buying into a megabank, but I can barely imagine, the Fed allowing a Chinese company buying a small bankrupt commercial bank in area with lots of people having financial transactions with China.

    Or maybe not…..

    One consequence of bank nationalizations may be that it may affect capital flows. If the US government runs GM and Bank of America, there will be strong political pressures for Bank of America to really be “Bank of America.” In this environment it would be much more difficult for BoA or any US bank to fund overseas operations.

  • Posted by Twofish

    Seth: Given the breathless coverage about 3-4 months ago about how letters of credit were drying up after Lehman’s bankruptcy, I’ve heard nothing. If they are in fact significantly harder to come by than under ‘normal’ circumstances, it seems plausible that this shortage of credit might be a contributing factor to the dramatic declines in trade volume and GDP being reported here and in Asia.

    Yes. In fact I’d argue that they are *the* contributing factor to the slowdown in China. If people in the US stop buying then it takes a few months of this news to get back to China. However, when Lehman went under, everything just froze solid in southern China, because credit just disappeared and factories could not pay workers even if they had orders.

    My other guess is that the “shadow banking” system in south China was supported by investment credit from Western banks. When people think of informal lending, they usually think of check cashing, pawn shops, and people in back rooms and street corners, but my guess is that the informal lending market in southern China was supported by letters of credit from Western investment banks and *not* directly by Chinese domestic savings. So when Lehman went under, the credit market in southern China collapsed in a way that it didn’t during the Asian crisis.

    This also explains one reason why China was so export oriented during from 2003-2008. If you fund a Chinese factory, you have to fund something that produces something you can get dollars for.

    This is all guesswork, but it is interesting guesswork.

  • Posted by Cedric Regula

    On letters of credit…

    The way they work is an importer places an order (with lead time) to an exporter(who may or may not carry inventory), or directly to a factory. The one that receives the order requests a letter of credit to that if they start work on an order or ship it from inventory that they are guaranteed payment by the importer’s bank. But before they get paid they must perform, the articles pass customer quality inspection, and then the importer pays in accordance with the terms of the order, which could be net 10, or net 30….

    Much of China’s exports go to companies like Wal-Mart, Target, Home Depot, Office Depot, GM, etc.. I doubt that Chinese companies ask for a letter of credit in these cases, except for maybe GM recently.

    It seems more likely to me that it affects Chinese companies on the purchasing end, i.e Texas Instruments wants one for the cell phone chip order from Mei Lie’s PCB stuffing company.

    That’ all conjecture on my part and I have no idea of the relative magnitude of these effects.

    On the Real Bank of America.

    Yes, It would become a political nightmare if US taxpayer money was ever squandered overseas!

  • Posted by john c. halasz

    Prof. Setser:

    Perhaps it might help to break out the actual composition of Chinese imports rather than just aggregate amounts in monetary terms. I’d doubt they import much by way of consumption goods as % of the total, so there would be three main groups of imports: 1) raw materials,- (and there are scattered reports that China has actually increased its purchases of raw material stocks to take advantage of low prices, which makes sense as a diversification move away from $ accumulation, especially building up a strategic oil reserve, putting it into the ground for roughly the same reason that low-cost oil producers would cut back on production, in which case, though the aggregate total on price might have gone down, the volume would have declined less),- 2) capital goods for its domestic economy, building infrastructure and the like, and 3) capital goods and higher-level intermediate components for its export sector. Now since major export countries, (developed East Asia, but also the likes of Germany), are experiencing a sharp curtailment in their exports, that would in part be due to a curtailment in Chinese import demand in groups 2 and 3. (The U.S. curtails exports to China for “strategic” reasons, so is not a favored source, but also it has maintained much less of its industrial base). A sharp slow-down in China’s domestic economy investment could account for the drop in group 2, but it’s just as likely that a sharp drop in China’s own export prospects has resulted in a cut back in Group 3, as there would be little point in adding more capital goods or warehousing intermediate components when factories are already closing up in the export sector, which decline in activity would also spill-over into the domestic economy and reduce group 2, as well. The upshot here is that it’s doubtful that China can grow its export sector much more, as the entire developed world economy has contracted by 1.5%, 6% annualized last quarter and figures to contract by at least as much next, as financial turmoil and collapsing RE bubbles in the deficit countries lead to a sharp retrenchment in consumer debt and, if anything, the surplus exporters are even more vulnerable. So my surmise is that China could only maintain its exports by cheapening them, but any depreciation of the Yuan would not be allowed by the RoW, and cheapening the value-added of its exports would run counter to China’s efforts to move up the value-added chain from no-tech to lo-tech manufacturing. (I’ve never understood why you’ve argued that China should concentrate on labor-intensive manufactures and not attempt to increase the capital-intensity of its manufactures, from the point of view of China’s development program, at least, which strikes me as a too simple H-O account of comparative advantage, when raising labor productivity is a key to raising wage levels and internally generated demand, and the aim clearly was to develop know-how in the export sector to eventually transfer it to the domestic demand sector, even if the forced savings through SAFE and SOEs has been excessive. Further, I don’t think that a “mercantilist” motive is the sole explanation of China’s US$ quasi-peg, though that’s certainly part of it. But still more basic is the maintenance of capital controls to maintain domestic policy control and especially over the domestic financial system, which makes Wall Street fantasies of gaining market penetration over there -except for AIG!- just another aspect of its delusions). So, if my surmise is right that Chinese export growth is at a standstill, if not an out-right contraction, since it can’t devalue and there is little point in reversing value-added and lowering quality to export low-margin output, then China is at a cross-roads, since there is little further point to accumulating more US$ by maintaining such a high import/export gap, though there is a temporary opportunity for using their US$ reserves to lock up resources and deals in the developing world, while their currencies have fallen against the US$. China will have to resort to a full-fledged New Deal type program, which might as well include WPA type low-wage public employment, together with PWA type infrastructure development, as well as more general domestic demand stimulus, perhaps partly as well, through relieving household burdens on savings for retirement, education and health care expenses to start to generate genuine domestic consumption demand. In that light, it might finally make sense for China to bite the bullet of capital losses on their accumulated for-ex reserves in exchange for lowering the domestic costs of imported inputs. And I would tend to interpret the flat-lining of the Yuan/US$ quasi-peg for the last 10 months, after accelerating appreciation at a 15% annual rate for the prior 6 months, as a frozen response to global financial turbulence and volatile and uncertain global forex rates, a wait-and-see attitude. At any rate, the current Wen and Hu team, having come up through Western China, do seem far more attuned and responsive to the dysfunctional side-effects and popular stresses of development than the previous, more neo-liberally inclined Shanghai gang. And their appetite to continue to swallow magically disappearing dollars down their gullet, especially in the light of their outrage, real or feigned, at Wall St.-style conjuring tricks, which have “magically” disappeared far more dollars, might be diminishing, especially as the Euro and other currencies figure, once the worst of the GFC has passed, to revalue in the face of massive U.S. debt monetization, in the effort to spark U.S. inflation/real debt depreciation.

    At any rate, that would be my speculative guess for now. So it might “pay” to scrutinize what exactly is causing the drop in Chinese imports currently, not just in terms of aggregate nominal prices, but in terms of disaggregated quantities.

  • Posted by Twofish

    Cedric: Much of China’s exports go to companies like Wal-Mart, Target, Home Depot, Office Depot, GM, etc.. I doubt that Chinese companies ask for a letter of credit in these cases, except for maybe GM recently.

    They do. Irrevocable letters of credit are the standard method of funds transfer in international trade. The basic problem is that the buyer can’t completely trust the seller to send the money and the seller can’t completely trust the buyer to send the goods. Since everyone is in a different country, you can’t easily rely on the court system to step in if something goes wrong.

    So in order to securely send money from one place to another you use banks as an intermediary. The buyer sends an ILOC the seller gets the ILOC and sends the goods. Once the goods arrive, the bank releases the money to the seller.

  • Posted by DOR

    Cedric Regula,

    If Joe Sixpack had lived within his means, there wouldn’t have been negative personal savings rates, over-consumption, record high household debt-service ratios and bursting bubbles. In other words, hey, no (more) credit bubbles.

    In addition, if the US government had lived within it means (e.g., as in 1996-2001), there wouldn’t have been a repeated record-breaking fiscal deficits, repeated record high federal debt levels, unprecedented demand for T-bills and the consequent prolonged low interest rates. In other words, no national default dangers.

    Further, if the regulatory authorities hadn’t been overwhelmed by technological progress, blinded by the “up is good / down is bad” stock market mentality, and hood-winked by credit rating agencies seeking to profit over Basel I and II bank capitalization requirements, we might have a solvent financial system.

    Did I mention how none of this is remotely related to China tremendous success over the past 5, 10 or 30 years?

    – – – – – – – – – –


    In Asia, L/Cs are still as scarce as hens’ teeth and twice as expensive. The downturn in demand, however, came first.

    – – – – – – – – – – – – – –


    1. It wasn’t Lehman’s that killed the L/C. It was a very broad loss of counter-party confidence.
    2. The ‘shadow banking system’ throughout China (not just the south) is wholly domestic. Households pool their money and borrowers bid on the funds. Very traditional, very local.
    3. Foreign lenders were scared away from “quasi-official” arrangements after the ITICs crisis of a decade ago.
    4. Capital controls are a joke; getting dollars to repay debt is not a problem in China. Pre-crisis, anyone who couldn’t accumulate sufficient dollars in a short amount of time and at competitive exchange rates wasn’t really trying.
    5. The reason China was so export-oriented in 2003-08 goes back to Joe Sixpack, and was greatly helped by a solid decade of huge capital flows that built the most modern, productive and cost-effective NEW manufacturing base in the world.
    6. The “slowdown in China” is, at least thus far, pretty much limited to the coastal regions. 300-400 million people is nothing to be ignored, but the other billion provide a very strong foundation. Private consumption expenditure, in my view, c a n n o t contract in China.

    Oh, and there is nothing ‘normal’ about the current circumstances. Nothing.

    – – – – – – – – – – – – – –

    Indian Investor,

    Your views on post-colonial capital bases and future development might be assisted by a study of Taiwan, ca. 1945-70. Lots of great infrastructure provided a solid base, but it was mostly neglected in the first decade.

    – – – – – – – – – –

    john c. halasz,

    China’s imports last year, by product: mechanical and electrical products were 41.9% of imports (Jan-Oct data) and the increase in imports of those products comprised 45.9% of the total increase in imports. ICs, LCDs and diodes were (together) 3.4% share and 4.1% of growth, respectively. Oil (crude and refined) was 7.2% of imports and 17.0% of growth. The data are here:

    Imports by foreign-invested enterprises comprised 54.4% of the total, about the same as the foreign share of total exports.


    = = = = = = = = = =

    Those who “cannot imagine” the US letting China (or other sovereign wealth funds) buy US banks or other assets are still in denial.

    This isn’t a recession, folks!

  • Posted by Jian Feng

    One can argue that the United States has already embarked on a path of the British Empire in liquidating dollar hegemony. Since there is no real alternative in the foreseeable future for China to stop buying US treasury, it will increasingly become clear that RMB and USD will effectively become one currency. Even when private investors stampede on US treasury, both China and US cannot afford to let the USD/Treasury fall. This strange marriage works exactly like the nuclear bundle theory has it.

    Does China want to buy the US banks? It depends on how China wants to make the international financial system work more favorably for China. There is the de novo method, which will cause lots of conflicts, if not wars. And there is the alternative – buy and assimilate. Is it too different from buying lots of steel factories in US, cutting them apart and reassembling them in China to make China the #1 steel producer? The banking industry in the US now is pretty much like the steel industry once upon a time. US sees troubles in them and China sees opportunity to get what China does not have, quickly.

    Although everyone hates Wall Street now, it is still the central nervous system of the Empire. Without Wall Street, who is going to do IPO’s to launch the next Google, who is going to disseminate the fiat, who is going to lubricate the engines of economy …?

    I think China needs them, quite badly, so that it can create its own financial system to park its huge reserves. Didn’t the Americans do the same thing to the British?

  • Posted by bsetser

    DOR. I guess I am in denial then.

    Banks are leveraged and regulated creatures. I cannot quite get my head around how the US government regulates a bank owned by another government. Nor can I quite see why the US gov would guarantee funding for a bank owned by another country’s government — yet right now few banks can fund itself without a government guarantee. Maybe China is willing to commit its reserves to backstop the deposits of its state-owned banks abroad .. but, well, that too raises a host of issues.

    And then there is the following issue: China’s government already has a $2 trillion unleveraged foreign balance sheet. Apply leverage to that balance sheet and it starts looking even bigger … and well, that strikes me a move in the wrong direction.

  • Posted by john c. halasz


    Thanks for the info and the link. Interesting bit here, of the top 10 import-surplus countries to China, Taiwan is 40% of the total and Japan and S. Korea 20% each.

    And the latest news flash over the inter-tubes is that Japan’s exports declined 46% y/y in 1/09, as opposed to 35% y/y in 12/08. It’s the latest Japanese monster movie craze: “Revenge of the Carry Trade!”

    So maybe my rough surmise of analyzing the composition of disaggregated imports, rather than just aggregate financial amounts might not be entirely off-the-mark.

    “Nor can I quite see why the US gov would guarantee funding for a bank owned by another country’s government…”

    As opposed to a government or governments owned by another country’s banks?

  • Posted by Ying


    What is the cutting point that the Chinese should learn from the US financial system? Should they learn the credit default swap, monte carlo simulation to calculate the value of mortgage backed securities or interest rate and currency derivatives?

    Derivatives has proved to prolong the credit expansion and hide risks in the balance sheet of corporations. It has been successful in transferring specific risks from the whole economy into systematic risks in a few number of financial giants. They don’t have much credit now. Though the boom is long, the bust is painful and long too.

    The risk and return calculation of wall street doesn’t work well for the long term prosperity of the whole economy. For private business, everyone should hire wall street analyst. But for the health of economy, profit maximization is a wrong-headed approach. For example, tobacco industry earn more profit than the education industry, should more money be allocated to produce tobacco? Some industries or sectors are badly needed for the health of the economy where resources can’t be allocated by private sectors because the value is extremely hard to collect. Such industries or areas include agriculture, forestry, renewable energy, education, environmental protection etc…

    The error of the risk return profit maximization system is that too much resources is spend and used on high value added consumption goods and services while ignoring the basic needs of the majority.

    My point is that it needs social study to define what goals the people want to achieve and where the economy should go instead of year after year few percentage point growth rate. Central industry planning with input from public spirited scientists, farmers, workers, educators, engineers etc. are needed to guide the direction of the economy. Modern computer system and Internet will assist in the transparency of the decision making process and information flow.

    Google is successful only because there is a need for its service and the value of the service can be captured by the private investors. The degree of such success is limited. I don’t object that there may be a certain portion of private funds that allow them to pursue their own interest.

  • Posted by Seth


    In Asia, L/Cs are still as scarce as hens’ teeth and twice as expensive. The downturn in demand, however, came first.

    Thanks for your reply. Can you elaborate on the sequence of events here? The L/C drought started at least as early as October of last year (based on the reporting at least), and the drop off in trade volumes appears to have come after the credit crunch.

    While I’m sure reduced demand is an important part of the story, I wonder to what extent the lack of credit may be amplifying the effect.

  • Posted by Kafka

    Mr. Setser, thank you, very nice analysis.

  • Posted by Jian Feng


    China of course does not need any of the new inventions made on Wall Street; they are largely designed to cheat people for their money. What China needs is how to manage its colossal savings and how to use the money on a global scale. These needs will become more acute as China amasses more wealth. When your bank account is 20% of the bank’s total deposits, wouldn’t it be wise to get yourself into banking business? After all, you put your money into the bank because the bank is making money and promises to give you a cut. To run the global financial system, China needs Wall Street experts, not charlatans. Hopefully, the nationalization-reprivatization exercise will weed out the charlatans and keep a few gems for a strategic buyer. It’s good that Russia is not a major counterparty to these zombie banks. Singapore and Abu Dhabi neither have nukes or a veto at the UN. Whoever buys the reincarnated banks has to accommodate these SWFs. China has no trouble doing that.