Brad Setser

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Did the Fed bail out China by buying Treasuries?

by Brad Setser
March 20, 2009

No. Not really. At least not in the sense that is usually argued. China has no need to sell foreign assets like Treasuries to finance its domestic fiscal stimulus so long as it is running a large external surplus.

But China could use a large buyer for some of its Agencies. Now it has one. Though here the Fed isn’t so much bailing China out as substituting for the falloff in Chinese and other central band demand.

And I would be curious to know if China is worried by the latest bout of dollar weakness or relieved that a weaker dollar is pulling the RMB back down. China’s biggest financial exposure isn’t to the equity market, it is to the dollar. It thus benefits financially from dollar strength. But a strong dollar also doesn’t exactly help China’s exporters. And exporters have long driven China’s policy choices.

Let’s start with the first point. Does China — as Felix’s correspondent implies — need to sell Treasuries to finance its fiscal stimulus?

The simple answer is no, it doesn’t.

Foreign exchange reserves can finance a current account deficit or a capital outflow. Foreign assets aren’t needed to finance a fiscal stimulus. The US is a case in point; it has financed a large fiscal deficit by selling dollar-denominated bonds — not by selling off its reserves. China would only need to draw on its foreign exchange reserves to cover its fiscal deficit if its fiscal deficit led to a trade and current account deficit.

And China no need to worry there. It isn’t Russia — a country that looks set to run both a fiscal and a current account deficit this year, and thus will need to draw on its reserves to meet the balance of payments needs associated with its fiscal deficit.*

Don’t take my word. Read the World Bank’s latest China Quarterly. Thanks to David Dollar, Louis Kuijs and the rest of the staff of the Beijing office, it remains the best single source for analysis of macroeconomic trends in China.

The World Bank forecasts that China’s fiscal deficit will expand by about 2.8 percentage points in 2009, with the fiscal deficit rising from 0.4% of China’s GDP to 3.2% of GDP (table 4)

The World Bank also forecasts that China will run a $425 billion current account surplus in 2008. That means Chinese investors — whether private investors or the central bank — will be net buyers of the world’s financial assets, not net sellers. China, like the Fed, will be buying Treasuries.

How can the fiscal balance deteriorate by 2.8% of GDP while the current account deficit deteriorates by only — according to the World Bank’s forecasts — 0.8% of GDP? Shouldn’t the fiscal deficit suck up some of the funds that China would otherwise lend to the world?

There is an easy answer here too: the rise in the fiscal deficit will offset a sharp fall in private investment, a fall that otherwise would have pushed the current account surplus up.

But aren’t China’s reserves falling because of China’s new spending plans? It is certainly rumored that China’s reserves fell by $30 billion in January. But the euro fell sharply against the dollar in January (after rising in December). Currency moves alone likely subtracted $40-50 billion from China’s reserves. If China’s reserves only fell by $30 billion, China was still buying foreign exchange in the market to keep its currency from rising.

Consequently, it is more accurate to say that China’s reserves are still growing, just at a much slower pace than before. More importantly, the currency slowdown in reserve growth isn’t due to a spending spree that brought China’s current account surplus down. Not at all.

Real imports — according to the World Bank (see Table 1) — fell by more than real exports in November, December and January. February will prove to be a bit different, but it is a month that is heavily shaped by seasonal factors. Nonetheless, China’s q1 current account surplus is on track to exceed its current account surplus in q1 2009, even with China’s fiscal stimulus.

On a rolling 12m basis, China’s trade surplus is at or near a record high, even including the February data. That may change if the global slump — now a quite severe global slump — continues to cut into China’s export and the stimulus reverses the slide in China’s (real) imports. But for now, China’s surplus is getting bigger not smaller.

So why has reserve growth slowed? Simple: private capital is leaving China. And that has nothing to do with the fiscal stimulus. It is tied to the dollar’s rise — and expectations that China might allow its currency to slide against the dollar to help its export sector.

For the year, the World Bank forecasts that China’s $425 billion current account surplus will lead to $425 billion in reserve growth, as “hot” outflows subside. That means that China will still be buying foreign assets, and unless something changes, it will still be buying Treasuries. Perhaps not quite at the same rate as before. But there is a difference between not buying as much and selling.

So what has China been selling? Simple: Agencies. That isn’t because China needs the money to finance its fiscal deficit, or (more realistically) to finance large capital outflows. It is simply because China seems to have lost confidence in the implicit guarantee that backs the Agency market.

What is the Fed buying: Agencies.

That helps China. If SAFE wants to lighten up its Agency portfolio — and it has a lot of Agency MBS — it can now sell to the Fed. That facilitates its exit from its large position in the Agency market. I suspect that China alone accounts for about half of all central bank Agency holdings — it is a huge player. The Fed, in effect, is making it easier for China to sell long-term Agency bonds and shift into short-term Treasury bills — or whatever other asset China wants to buy.

That help though isn’t free.

The Fed’s move has pushed the dollar down v the euro. And helped push oil up. Neither helps China financially. If China wants to shift from say Agencies to bunds, it is now easier for it to trade its Agencies for dollars, but each dollar buys fewer euros.

The dollar’s share of China’s reserve portfolio exceeds the United States’ share of China’s imports. The more the dollar falls over time, the fewer of the world’s goods China can buy with all the dollars it has salted away. And the more the dollar falls, the more likely that the RMB will eventually resume its rise against the dollar.

That also doesn’t help China financially. China’s government has borrowed in RMB to buy dollars and to a lesser degree euros, effectively opting to hold more reserves than it needs to support its export sector. The ultimate cost of that policy hinges on the dollar’s ultimate fall v the RMB.

SAFE thus should want a strong dollar, as it is fundamentally long dollars. Relative to other reserve currencies. And relative to China’s own currency.

Then again China’s policy of building up far more reserves than it needs never made much financial sense. China wasn’t all that happy with a strong dollar, even if that was in its financial interest.

The RMB has appreciated far more in real terms over the last nine months — when it has been tightly pegged to the dollar — than it ever did back when the RMB was appreciating against a depreciating dollar. My guess is that Europe is far more worried by the dollar’s recent slide than China. China — or least its exporters — weren’t happy with the RMB’s recent strength.

The Fed thus, in some sense, bailed out China’s exporters far more than it bailed out China’s reserve managers.

Actually, it makes more sense to think of the Fed as substituting for China in the market for Agencies — and other central banks — than to think of the Fed as bailing out China and other central banks. The end of the foreign central bank bid, as global reserve growth slowed and central banks shifte dto Treasuries — has had a big impact on the Agency market. That wasn’t helping the US housing market.

Nor is the Fed just stepping in to buy the Agency bonds central banks now want to sell. It is also trying to substitute for the collapse in private financial intermediation here in the US. Private banks have gone from lending huge sums for almost nothing to not lending even when spreads are much higher for the same risk.

Put it this way: foreign central banks never bought anything close to a trillion dollars of Treasuries and Agencies in a single year. A half trillion or so of annual purchases was more than enough to have an impact ..

* Russia is effectively using its reserves to make up for the fall in the government’s export revenues. Absent a buffer of reserves, that short-fall would have required that Russia reduce both government spending and its import bill.


  • Posted by Roc

    Brad, you suggest that the Fed is offering China an exit strategy for part of its agency holdings. Is there any quid pro quo, explicit or implicit, that you see here?

  • Posted by Rajesh

    I don’t suppose you want to take on the topic of “Did the Fed bail out PIMCO by buying Agencies?”

  • Posted by purple

    My own perception is that the Fed feels comfortable with the strength of the dollar relative to other currencies, or they wouldn’t have done this.

  • Posted by jonathan

    The dollar’s value is a loop for China, helping with one hand and hurting with the other. They really are long and short, with the short side showing in exports (and all the internal politics that depends on that).

    Thanks. This was very interesting.

  • Posted by WStroupe


    Maybe the Fed is offering China a chance to more fully sell out of its agency debt in return for China stepping up to keep buying Treasuries, as the Fed promises to keep long-term rates low so that the value of China’s huge holdings of longer-dated Treasuries won’t be ravaged over time.

    China will probably not increase its exposure to the longer-dated assets much more, but it might keep buying big sums of short-dated Treasuries while it divests of agencies. Wouldn’t that help it keep the rmb at the desired level against a falling dollar?

    Simultaneously with all this, China could kick its resource buys into higher gear so as to further convert dollar reserves into resources reserves and stakes in resources companies around the globe.

    Overall, though with some costs, it looks to me like the Fed is giving China a limited window of opportunity to decrease its exposure to the dollar, while China gives the U.S. a lifeline for its spending programs in this crisis. But I think the ‘deal’ lasts only for a relatively short time, until inflation rears its ugly head again. China’s got to get set to take care of itself then, in case the U.S. finds it impossible to control the inflation monster.

  • Posted by Indian Investor

    Brad Setser:It isn’t Russia — a country that looks set to run both a fiscal and a current account deficit this year…

    Me: According to data from the Bank of Russia (link below), Russia’s current account balance is positive so far, and overall exports are growing, not falling.

    Are you making a projection for the rest of 2009 in terms of ‘set to run …a current account deficit’?

  • Posted by WStroupe

    I think China may not only use this opportunity provided by the Fed to divest of big chunks of agencies, but also to divest of a good chunk of its long-dated Treasuries, since the Fed’s going to be buying these assets too.

    It’s going to be too tempting for China, because as the Fed drives yields on the long-dated Treasuries lower, China can sell at little loss, no loss, or even at a profit. So I think we’ll see a conversion from long-dated Treasuries to short-dated Treasuries going on, as well as a conversion from agencies to short-dated Treasuries. It isn’t a sell-off, per se. But it’s a flight to a position of much higher liquidity for China. It’s a move to a position where China can act much more quickly to protect its interests, if it deems certain actions necessary. And it’s a flight from potential ravages of inflation which hits the longer-dated assets harder.

  • Posted by Don the libertarian Democrat

    “It is simply because China seems to have lost confidence in the implicit guarantee that backs the Agency market.”

    I’ve been fascinated by this, because the implicit guarantee is not thought to be explicit by China, and yet I keep thinking that we’re signaling that the guarantee is explicit without saying so. Since this has been going on for so long, didn’t that move signal something negative about their trust in our guarantees.

    Also, if they can earn more interest and the Fed is buying them, why wouldn’t they leave them in agencies now? It would seem a better move to diversify a bit and buy some of these agencies, especially, again, since they’re being essentially guaranteed.

    I thought that China was mainly worried about possible defaults or haircuts on corporate bonds, since they seem to believe that these are implicitly guaranteed by us, or were when they bought them.

    Finally, I thought that China already knew this:

    “China to stick with US bonds

    By Henny Sender in New York

    Published: February 11 2009 23:33 | Last updated: February 11 2009 23:33

    China will continue to buy US Treasury bonds even though it knows the dollar will depreciate because such investments remain its “only option” in a perilous world, a senior Chinese banking regulator said on Wednesday.

    China has used the dollars it accumulates selling manufactured goods to US consumers to accumulate the world’s largest holding of Treasuries.”


    “Mr Luo, whose English tends toward the colloquial, added: “We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.”

    This doesn’t sound like Luo would be happy with what we’re doing. What am I missing?

  • Posted by Qingdao

    From the WB Quarterly Update, Mar. 09: plunging exports and imports (fig.2); plunging market based fixed asset investment (fig 4); plunging retail sales and consumer confidence (fig 6); plunging (negative) CPI, PPI (fig 7); profits negative (fig 9). Rising indicators: bank lending (fig 3); base money (fig 10); government fixed asset investment (fig 4). From this happy picture, the WB predicts 6.5% growth in 09 (table 4); the same as Q4 08 (fig 1). This same WB that saw pork prices driving inflation in 07,08 and dismissed all arguments about the rmb and hot money inflows, now dismiss hot money outflows:

    Moreover, reserves are so large that, even if, as is unlikely, a few hundred billion dollars of non-FDI capital were to leave China, that would not be a major concern. (p. 23)

    I’m willing to out on a bamboo limb and argue (1) the vaunted 4T stimulus package will not result in 6.5% growth; (2) “a few hundred billion dollars” leaving deflationary China will be a concern.

  • Posted by gillies

    Roc : “Brad, you suggest that the Fed is offering China an exit strategy for part of its agency holdings. Is there any quid pro quo, explicit or implicit, that you see here?”

    they do not put the terms of the deal in the newspapers – so what clues have we ? not many. but there are public statements. leading up to hillary clinton going to china there were examples of people in high places ‘thinking aloud.’ you can take it that people in high places do not think aloud, but make carefully nuanced statements preparing the ground. the answer has to be that there is a quid pro quo – a deal. so the question to ponder is to put yourself in their position – what would you want ? and is it possible to imagine a deal that gives both parties what they want ?

    what is wanted is to print money, but without collapsing the bond market. can these two objectives be separated ?

    and is this what the mechanism of the fed buying treasuries is about ?

    its the $64 trillion dollar question. frame the question better youself if you can. answer it better if you can. but i think the question is to find a deal that devalues the dollar without triggering rises in interest rates.

    i am only guessing in the dark – but i do not expect to find the answers to high level diplomacy in newspaper headlines. but my impression was very clear that something agreeable to both parties was stitched up recently, between the u s and china, and why not ? both economies have so much to lose. confrontation is a phony option.

  • Posted by gillies

    and that ‘we hate you guys . . .” remark was as scripted as armstrong stepping on to the moon. probably not scripted in china, either.

  • Posted by wally

    “The Fed” doesn’t bail anybody out… it forces us to do so.

  • Posted by bsetser

    WStroupe — interesting comment. China doesn’t really need any more liquidity (it already has a huge bill position), but it might choose to take profits on its notes. But at some point it also won’t want to hold zero coupon bills — as it does need a bit of carry to generate income to cover its sterilization costs. My thinking is that this would limit China’s desire to shift from instruments with some carry to instruments with no carry.

    on the other hand, booking a capital on treasuries might help it offset losses on its equities, so that might be an attractive trade — even if it means giving up income.

  • Posted by Simon

    David Dollar?? cool! nearly as cool as Fabious Maximus at RGE. I’m thinking of changing my name to Simply Stupendous. In many ways appropriate.

  • Posted by don

    I view China’s trade surplus as a policy-determined variable, pure and simple, owing to thier large currency interventions. It will be interesting to see what will happen to it with the decline in global trade and aggregate demand. If the yuan starts to decline to maintian the surplus, I think my view would be vindicated.

  • Posted by Cedric Regula

    I guess one thing that could be a US-Sino collusion possibility is to both weaken the dollar and RMB to support both Chinese and US exports. Weaken against what is the question, and with Japanese QE minutes away, the euro would be the last major left. Not that it would work, but that hasn’t stopped us before.

    My guess what the USG really, really, truthfully wants to do is print money and fight this deflation monster that is hiding under our beds and scaring the crap out of us. Krugman even thinks that’s the reason, and he’s sleeping better already. Krugman knows that nothing stimulates an economy better than convincing everyone their money is no good, so they run out and buy a house or something.

    The Ministry of Chinese Chaos Theory Mathematicians have already figured out that if the Fed buys $300B of the 10 year over the next 6 months, things look good for 6 months, then they stop (let’s keep our taxpaying fingers crossed), and then things look really, really, bad for 9.5 years.

    Same goes for mortgage paper, even with the spread it’s way below historical average.

    So it’s hard to imagine the Chinese will do anything but buy and hold T-bills, in the best case scenario.

  • Posted by WStroupe


    I see your points – China knows it can’t have everything its own way, so it will likely chose what it considers most important to have its own way, and lock in those advantages.

    We know each entity in this play is going to fundamentally act in its own interests, both short and long-term, and will consider repercussions of its actions only insofar as it impacts its own interests, so where China’s and America’s interests match up, they’ll both appear to be acting in harmony with each other.

    Hence, it really appears to me that their interests mostly match up in the short-to-medium term at best. China’s got to be increasingly worried about the medium-to-long term effects of U.S. policies (inflation, etc). Does China place confidence in the U.S. ability to prevent the inflation monster from arising down the road? I’m doubtful it does have such confidence.

    So I think China’s going to ‘work it’ pretty hard in its own favor while it can, during the opportunity the Fed’s afforded it the chance to change the composition of its reserves. Does China see that it now has the Fed ‘on the hook’, as it were? I mean, the Fed can’t reverse course and NOT buy Treasuries and Agencies. Also, if China’s rebalancing of its reserves should hit longer-term yields and make them begin to rise, doesn’t the Fed have to step up with more purchases, otherwise it loses valuable credibility? And if you look at all the new issuance coming online, I think the $300 billion the Fed plans to buy is much understated – it will have to buy much more than that, I think.

    So I see a situation where the U.S. believes China will work with it in this unspoken ‘deal’, and I think China will do so, but not in all the ways and not as long as the U.S. hopes. China’s leaders have got to be secretly lighting up the BIG CEEGAR and feeling pretty darn good about these recent developments. But I don’t think they will get over-confident and ‘screw the pooch’ – they’ll just be deliberate and careful and get done the rebalancing of their reserves that they need to do.

    We’ve heard a lot about how China ‘has no choices’ because if it does anything with regard to reducing exposure to the dollar then it stomps on its own interests. To a significant degree that is certainly true. However, it is not true to a complete degree. It has advantages over the U.S. simply because the U.S. house is in such a desperate situation. The Fed’s got to do what its doing. China sees clever ways to leverage it to its own interests, and the U.S. can’t do a whole hell of a lot about it.

    When you’re arm-wrestling some guy, you can win if you have even a relatively small advantage – you don’t need to be twice the brute he is. You just need to be a little smarter, too. I think China’s advantages are not colossal, but just enough to put it ahead in this game.

  • Posted by Ying

    Is there any possibility that the recent fed move might be aimed to save the interest rate derivative market from falling? Check the link and you will see that 78% of notional value(176 trillion in total) are from interest rate related derivative products. Top five banks dominate the majority of the market. The revenue from interest rate derivatives are in trillions though the net is not that big. In page 9, the dealer notional is much bigger than the end user notional value. I am wondering if dealers are buying insurances against each other.

  • Posted by don

    Usually, trade partners don’t compete for gain against each other, they both gain in a kind of symbiotic relationship – both are enriched from the opportunity to trade and trade expands the global production possibilities frontier. In the current environment, however, the issue is whether countries can gain or lose aggregate demand through trade. The temptation will be strong to use currency policies to gain through current account balance improvement. If cordial relations break down and unemployment pressures become great, the result can be a great contraction of trade.
    China would lose very greatly from such a development.

  • Posted by Cedric Regula

    Ying:”Is there any possibility that the recent fed move might be aimed to save the interest rate derivative market from falling?”

    The Ministry of Chinese Chaos Theory Mathematicians believe this may be the Number One reason. They programmed their Japanese Supercomputer with ZIRP, QE and interest rate(and default) insurance. The computer made a burping noise, spewed out DEBT DEFLATION on the printer, then smoked all it’s transistors.

    They then programmed the same model into the backup French Supercomputer along with the question “When”. The computer printed out “Whenever Ben stops buying everything”, then did the same thing the Japanese Supercomputer did.

  • Posted by Bob_in_MA

    I agree with Qingdao. That World Bank report seemed to project a pretty painless adjustment for China. It doesn’t take much skepticism or knowledge of economic history to find that somewhat naive.

    I predict that much of China’s stimulus is going to be adding fuel to the fire by promoting investment in over-capacity and unproductive lending. They may get a nice jump in the stats for a quarter or two, but I think they are going to pay the piper, and it won’t be pretty.

  • Posted by Curious

    long term China will be fine. how many more gadgets can western consumers purchase?

    international financiers have eyes focused on China. China has huge savings, once they start to spend (have a solid middle class) the consumption model will pick up and international corporations that are lined up for a nice marketshare of the asian region will do extremely well.

    why focus on a population that’s burdened in debt, over consumed, and in eyes of the internationalist view “dead”.

    The opportunity is in emerging markets. And the opportunity is immense.

  • Posted by WStroupe


    You hit the bull’s eye! And just think of the swiftness with which the emerging markets will get back on their feet when the vast sums of wealth now excessively tied up in the Treasuries bubble begin to flow their way.

  • Posted by yoda

    i would think Fed declared war on their two main foreign creditors China and Japan. Printing money out of thin air is indirect default. if this is not war on foreign creditors, then i dont know what is.

  • Posted by yoda

    potential forex loss out-weight short-term tiny gain on swapping out of long-dated treasury to short-term treasury. pointless to debate on this part. this is all out war against foreign creditors. forcing foreign creditors to take absolute loss on forex.

  • Posted by yoda

    for foreign creditors, there is only one way to mediate that huge forex loss. they have to print $1.2Trillion dollar equivalent currency and prepare to print more in the future to maintain current forex. but that will mean currency armagedon crisis spiral out of global hand.

  • Posted by Cedric Regula


    The Ministry of Chinese Chaos Theory Mathematicians have determined the amount to be much greater than $1.2T. They rightly point out that the Sith come in pairs. Darth Geithner or Geithner’s predecessor, Darth Paulson and the Sith Emperor, Ben Bernanke.

    The total contribution from the Emperor is something like:
    $1.2T in total MBS purchases
    Up to $200B in GSE corporate debt
    $300B in long term treasury purchases
    Up to $1T in TALF
    Plus other items contributing to the Federation Reserve balance sheet expansion so far.

    I’m sure Brad will do an article soon about how the trade deficit defines our dependence on foreign financing. I’m still hoping I can understand that concept better.

    Then there is the Death Star. The fiscal deficit to fund the Death Star is estimated at $1.7T, even tho the latest monthly read on tax receipts puts us at the 1985 rate. Assuming that doesn’t cause any problems with the math, then Emperor Bernanke is funding $300B of that. That leaves Darth Geithner to finance $1.4T elsewhere.

    So eyeballing that puts us over $4T.

    As a result of this analysis The Ministry of Chinese Chaos Theory Mathematicians is recommending to the Party that R&D investments in high speed printing press technology are necessary.

    They acknowledge that adequate printing presses could be purchased from either the US or Japan, but it is preferable to develop this industry domestically.

  • Posted by Twofish

    Ying: Is there any possibility that the recent fed move might be aimed to save the interest rate derivative market from falling?

    Interest rate derivatives aren’t have problems right now. The markets that are failing are the securitization market.

    Also, one has to be clear about what it means for a market to “fail”. If people are buying and selling, then the market is operating. It doesn’t matter if the Dow is at 500 or 50000. As long as people are buying and selling then the market is working.

    What a market failure looks like is when you have no buyers and sellers, because the sellers think that something should be 60 cents and the buyers that that something should be 30 cents. If both buyers and sellers think that something should be 30 cents or 60 cents, then there is no problem.

    This is happening in real estate and in the securitization markets. It’s not happening in IRD’s, where buyers and sellers agree to the price.

  • Posted by Twofish

    yada: i would think Fed declared war on their two main foreign creditors China and Japan. Printing money out of thin air is indirect default. if this is not war on foreign creditors, then i dont know what is.

    I don’t think it is “war.” The problem with being a foreign creditor is that if you are being debt denominated in the debtors currency, you have to realize that they can and will inflate the currency if they think that it is their national interest to do so. On the other hand, if the US does increase demand, this will also increase Chinese and Japanese imports.

    It’s also not clear that printing money will increase inflation. There have been whopping huge amounts of money printed in the last few months but no inflation. If people’s first reaction to getting a dollar bill fresh off the presses is to burying it into the ground, then you won’t get inflation.

  • Posted by 1currency

    Please proofread and use spell-check. There are many errors in just the first 2 paragraphs. Your writing is too good to be diluted.

  • Posted by Twofish

    As far as agencies go.

    The “implicit guarantee” on agencies has disappearred. There was an implicit guarantee on agencies until July at which point Treasury stepped in and replaced it with a limited explicit guarantee of $100 billion. Most people don’t think that Treasury will put much more money into Fannie and Freddie than that $100 billion, and if Fannie and Freddie losses exceed that amount, they will fail, and everyone (including the Chinese government) is acting based on that assumption.

    This is good and intentional, but it has consequences, namely that people aren’t that interested in buying agency bonds any more.

    Part of the problem with “let them fail” is that you have to figure out what happens after they fail. One good thing about private securitizations is that lots of people lost lost of money. If you are a bank with lots of mortgage securities, you may get bailed out you have insured depositors. If you are AIG, then you get bailed out because you have written lots of insurance policies.

    If you are a hedge fund or pension funds, you are just out of luck, and hedge funds have been failing left and right. The fact that hedge funds have been failing doesn’t make the news, and that is a good thing. When a hedge fund fails, nothing bad happens, except that they sell all of the stock that they were holding, which is why the Dow is at 7000.

    All this is fine, except that if you survived, then are not in the mood to buy mortgage-backed securities or loan securitizations the next time without a deep discount or guarantee.

    This is one reason that buyers and sellers of mortgage loans have radically different views of how much those loans are worth, because the sellers (i.e. banks) are insured whereas the buyers (hedge funds) aren’t.

  • Posted by Twofish

    Don: “Mr Luo, whose English tends toward the colloquial, added: “We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.” This doesn’t sound like Luo would be happy with what we’re doing. What am I missing?

    I don’t think you are missing anything. The Chinese government probably hates the US government a lot for depreciating the dollar, but unlike the US House of Representatives, the Chinese leadership is capable of taking some deep breathes and not act randomly from emotion.

    If you have some ideas for what China could do that would improve its situation, then Beijing would be interested. The only obvious things would be depeg, cut imports and move from the dollar to the euro. The first is already being done. The second is not a good idea, if Europe starts printing Euros.

    But “you are hurting me, therefore I will hurt you, even if it ends up hurting me more” is something that doesn’t work.

  • Posted by Stefan

    China wanted to save, the US private sector wanted to borrow =>equilibrium
    Suddenly the US private sector did not want to borrow any longer =>overproduction, deflation and crash

    Basically China will continue to save/produce and the US will continue to borrow/spend
    Equilibrium is reached when the US current account deficit as percentage of GDP equals US nominal GDP growth
    US foreign debt approaches 100% of nominal GDP.
    5% current account deficit is no problem if GDP grows 5%. Outstanding debt over time approaches 100% of GDP. (Capital account disregarded.)

    For China, every year their additional currency assets are equal to the dilution of their existing assets.

    Their is an equilibrium between the US current account deficits, and the US nominal GDP growth. This crisis came about as the deficit overwhelmed the nominal GDP-growth.

    Fed:s inflationary measures are restoring order, and we will end up where we were. China exports, the US imports, and inflation takes care of the clearing.

  • Posted by Stefan

    China’s marginal utility of extra dollars to its currency reserve is obviously close to zero.

    So why does China continue to add reserves? Answer: Because their relative share of all outstanding dollars increaes with every new dollar added. Mercantilism is not about optimising utility, but about accumulation for the sake of accumulation. Storing money becomes a false proxy for storing wealth. This fallacy can only be encountered by printing money.

    This is also the reason why a gold standard currency system is impossible. Some people would simply accumulate for the sake of accumulation, gold-denominated assets would become scarcer and scarcer and we would end up in hyperDEflation.

    The Fed is acting correctly. China should not have accumulated dollars, but should have purchased real US assets and products. Technically this would have been achieved by letting the RMB float.

  • Posted by DJC

    Obviously, the concern is that those with still the capital to lend to the US, primarily China, seeing the huge increase in US government demand for borrowed funds with its now huge and ever-burgeoning budget deficits being used to finance the economic crisis recovery programs, will fear that the US dollars they use to buy US debt will depreciate in value, devastating the value of their investments.

    Previously, China has tried to give messages that slowly pulling out of its dollar positions was exactly what it wanted to do, but America’s cherished habit of ignoring anything that foreigners say to it had it lending a stone-deaf ear to the warnings.

    Last week, as detailed on this site with W Joseph Stroupe’s three-part series (see Dollar crisis in the making Asia Times Online, March 14-18, 2009) and by Olivia Chung’s article on Chinese Premier Wen Jiabao’s warning to the US to maintain the value of its currency as a matter of national honor.

    So Ben Bernanke decided to give America’s Chinese and other foreign investors a good swift kick in the keyster as they headed out the door. In other words – foreigners, we don’t need your money; we’ll print our own!

  • Posted by Geithner_Bombed

    Anyone Check Geithners latest proposal?

    Another horrible idea, what does this guy who comes from the NY Fed not understand? Everything this guy has said has been a terrible mistake, mistake after mistake. Mr.Geithners been wrong for over a decade and the bank proposal of this weekend just goes from bad to worse.

    Who gives Geithner the authority to “bail-out” by buying assets which will be inflated at 50-60% above market value, at thus a moral hazard to the U.S. TAXPAYER?

    I’m looking forward to see Geithners next proposal, I will send it to my lawyers for review and then outline exactly that this is once again a scam to bail out friends on wall street through the U.S. Taxpayer.

    The correct thing to do, is do the Swedish-model. nationalize the entire sector, all these assets are TOXIC. They’re likely worth pennies on the U.S. dollar, for the U.S. taxpayer (AND NOT PRIVATE INVESTORS) to take the bulk of this risk is plain insanity.

    I guarantee this proposal will create massive outrage, and when it FAILS there’s going to be all sorts of trouble

    -food riots
    -tax revolts

    just the start, Mr. Geithner, needs to TOUGHEN UP. Be a man, stand up and say you NATIONALIZE or you FAIL. period.

  • Posted by Geithner_Bombed

    not only am i upset, and extremely saddened by Geithers proposal outlined. but it seems as if
    Princeton University Professor Paul Krugman
    seems more even more OUTRAGED.

  • Posted by WStroupe

    This awful plan is being offered by Geithner at a very inopportune time, too. Just when the global debate and negotiations over how to reform the international financial order are getting underway. This week, (March 25)the UN presses to ditch the dollar as the international reserve currency, and next week the G20 takes up the agenda of reform of the global financial order. The U.S. negotiating position is already decidedly weak – this crisis emanated from the U.S. If Geithner’s plan is received by the UN panel and the G20 as it was received by Krugman, then we’re going to go into these very, very tough debates and negotiations with a position that is only much further weakened. This is not good news for the U.S. and the dollar, because the dollar’s going to take multiple hits from rival powers, as well as the hits it’s taking from Washington’s shortsighted policies.

    Those who always ASSUME the dollar can take the heat, as it always has before, may well get a shock this time around. We’re entering a period of weakness for the dollar that may be unmatched in recent history. And we’ve got rival powers just itching to capitalize, and wanting to bring in a new order that promotes multiple other currencies to the international fore, at the expense of the dollar’s present sole position at the fore.

    Has anyone checked Geithner’s bank statement lately for large foreign deposits of cash?

  • Posted by Indian Investor

    The word ‘China’ is used 59 times in the above brief essay. The usage isn’t totally clear. Either it refers to a few people at PBOC,SAFE,CIC, etc; or to the Chinese nation; or perhaps to the billions of Chinese people;especially, there’s no differentiation between the Chinese diaspora, and local Chinese people. Perhaps soon “China” will come to represent something very close to “Islamic terrorism”; with references to ‘financial terrorism’.

  • Posted by jl

    UN has had hopes for a global currency since it’s foundation. this crisis provides dream to become reality.

    i hope U.S. complies, it’s in the United States interest to have a new global order=new global reserve currency vs. the possibility of the dollar being ditched for the yuan in 10 years.

  • Posted by jl

    If the U.S. complies to the vision of a new global order, as proposed by the EU and Asia then this will help re-shape the world’s global imbalances.

    2010 could be the beginning of some global light, but it will take international cooperation and the allowance of the traditional west to acknowledge the presence of emerging players.

    of course, it is my opinion that failure to organize this new international system will have dire consequences, for both the greenback and sterling.

    it is interesting that not much of this has been discussed in news. But let us hope it has been discussed and compromised by our leaders in d.c.-london-tokyo/beijing.

  • Posted by WStroupe


    The UN-sponsored global currency dream is obviously the end point of its current push against the dollar. I think matters could eventually end up that way. When, how soon, I don’t know. But screwing the brains out of the dollar, as Washington seems intent on doing, certainly opens the door to the realization of such dreams (nightmares). But even before that, the idea of promoting multiple currencies to the international fore presents a real, swarming threat to the dollar, in my view. The Babylonians are at the gate, and they’re deadly serious.

  • Posted by WStroupe


    Question is, would a transition from the dollar to something else, like a basket of currencies, be orderly or chaotic for the dollar and for the U.S. and its closest allies?

    My bet is chaotic.

  • Posted by jl

    i dont think it’s a good idea to discuss the topic on this board because of all the conspiracy “nuts” who fail to understand the world’s global imbalances…..

    a new global reserve would provide an ‘orderly’ readjustment. it is without the fulfillment of this idea that you may witness “chaotic”.

  • Posted by WStroupe


    I agree with you that without a new reserve currency(ies) we’re going to get the chaotic endgame.

    But I’m not nearly convinced the transition to such a new reserve would be orderly, for the U.S. and for the dollar. I see an eventual dollar collapse as virtually unavoidable, almost no matter what we do.

  • Posted by Plan B Economics

    Looks like China’s staying put for now…but they’re undoubtedly concerned.

    Time for an insurance policy against inflation?

    We’re only 5 steps away from hyperinflation:

  • Posted by Indian Investor

    Mr. Stroupe, Thanks a lot for very clear analysis of the approaching dollar crisis. I assume a chaotic collapse of the dollar can result if a group of very large holders of Treasuries head for the exit together. Foreign central bank managers appear to be caught between the Devil and the Deep Sea. If they suddenly stop pegging to the dollar, it can have a huge negative impact on export profitability; closure of factories and much more massive unemployment will result. So they can exchange dollars for hard assets in a steady manner, even while continuing to buy enough to maintain a peg. Fed monetization does weaken the dollar, but several countries have had to dilute their currency in the global financial crisis through the monetization route to fund their domestic stimulus packages.
    Another option for FCB dollar exit is to offload US Treasuries in favor of other government debt. This will, for instance, strengthen the EUR against USD, without weakening RMB against EUR.
    I think there’s a good chance that the process of adjusting to a new reserve will take several years, due to constraints in implementing the domestic infrastructure programs in emerging markets. Unless countries like China are able to develop their local market for employment, they can’t stop pegging to the dollar.

  • Posted by Stefan

    The dollar can only crash if the Chinese and the Arabs give up the peg. And they will not. Simple. Even the Europeans and the Japanese eye the dollar and pursue their monetary policy relative to the value of the dollar.

    We may discuss US macro here as much as we like, but when most of the world has de facto pegged themselves to the US, the only relevant macro is that of the entire world dollar zone.

  • Posted by Stefan

    The dollar printing may benefit the US more than it benefits China. And it may benefit Michigan more than it benefits Wisconsin. This does not necessarily mean that any serious tensions would arise between the geographical areas mentioned.

  • Posted by Stefan

    IF China would give up the peg, the dollar would depreciate, and the US would not need to print money.

    China pegging begets US printing.

  • Posted by WStroupe


    The problem for the U.S. dollar is that if the U.S. economy and market doesn’t come back very soon, then the efforts of the Eurasia to make the transformation to a new driver, increased domestic consumption and increased trade within Eurasia, will get much greater impetus. If the rest of the world works to get past the U.S. market as the key global economic driver, then there’s much less reason and benefit in pegging to the dollar.

    In my view, by painful experience (this global crisis) Eurasia and Latin America are being forced to do just that. It hurts BIGTIME. But they’re doing it because they have no choice. The U.S. economy is unlikely to recover soon enough and energetically enough to derail this project. That bodes ill for the future of the dollar on the international stage.

    The rest of the world just waiting idly on the sidelines for the U.S. driver to recover is not an option this time around. The pain being suffered is far, far too great to consider that old option. And you’ve got potent new players like China in the mix, which you didn’t have before.

    Dollar pegs are getting much weaker legs. This crisis is a watershed for the dollar.

  • Posted by ole_charlie

    Barney Frank wants the Fed to have more oversight of the financial system. Hmmm, let’s give two quotes from guys at the Fed and let you decide if you want the Fed to have all the power to regulate our key economic component.

    “If we all join hands and go buy a new SUV, everything will be all right,” – Bob McTeer, Dallas Fed governor -2001

    “What we dearly want is for Americans to spend like Americans – to do the patriotic thing and go out and spend,” – Bill McDonough, head of the New York Fed, October ’01.

  • Posted by Indian Investor

    WStroupe: That bodes ill for the future of the dollar on the international stage.

    Me: I’m interested to know if you think a weak dollar will be good or bad for the US economy. As long as the US Treasury doesn’t face an external financing solvency crisis, the weaker the dollar, the better it is for the recovery of the US economy.
    As the dollar weakens, profitability of existing export businesses will increase, and foreign demand for US goods will probably increase as imports from the US become cheaper in local curreny terms.Both of these are good for employment levels in the US.
    There are some industries that are more labor intensive and less technology driven. In those businesses export prospects can only improve after a few years when the real wage levels of US workers are more in tune with wage levels abroad.
    Meanwhile the task is to reduce dependence on imports and create a situation of fiscal stability where the Treasury securities can be reliable without the dollar being the world’s only major reserve currency.

  • Posted by cmc313

    Dr. Sester & other esteemed colleagues:

    BOE, BOJ, the Swiss and the FED have all embraced quantitative easing. If the ECB adopts this policy as well, would it then become a coordinated policy to debase debt which winds up benefiting developed countries at the expense of China?

    My layman’s understanding is that the danger in printing money is that one’s currency loses value. But if all major economies start printing money in a coordinated fashion, their currencies should not weaken against each other. But their currencies would weaken against those of Asian exporters who happen to hold our debt. So the Chinese wind up having to revalue their currency while losing their shirt on all the debt securities they own. This in essense achieves the global re-balanching goal while helping developed countries escape from their high debt burdens.
    Could you tell me what’s the flaw in this line of thinking? Thanks.

  • Posted by LawrenceW

    The question should be
    “Did the People’s Bank of China bail out USA by buying Treasuries?”

  • Posted by bsetser

    right now dollar pegs are under strain because of dollar strength, not because the fed is printing money; to the extent that the dollar is now falling v the other major currencies that helps china’s exporters; and the concurrent dollar fall v euro/ rise in $ price of oil helps the GCC countries.

    cmc313 — if the ECB joined in, a coordinated monetary easing wouldn’t change the relative values of the major currencies, so China’s dollars would buy as many euros and india’s euros and pounds would buy as many dollar. And if china remains pegged to the dollar, it would join in the coordinated monetary easing. if the market didn’t believe that loose US monetary policy was right for China, hot money would start to flow into china. and if china wanted to maintain its dollar peg, that would imply either allowing the hot money inflows to push up China’s money supply (i.e. joining the coordinated monetary expansion) or doing a lot of potentially costly sterilization.

    The alternative is a revaluation – and then letting the RMB float, which would allow China to adopt its own monetary policy. The RMB value of China’s foreign assets would fall. But that is something that China is almost certain to have to accept at some point or another in any case. the only real question is when.

    Right now my sense is that China wouldn’t mind a weaker dollar/ looser US monetary policy all that much — as that helps reflate its domestic economy, and that presumably is china’s primary interest. it seems to me to be a strange time for China to start worrying about the external value of its portfolio now. the time to do so was a few years back, before China opted to buy up a lot of reserves it didn’t need.

    My view tho is shaped by my strong belief that China will eventually have to revalue its currency v a basket of euros, yen, pound and dollars, and thus China will take losses on its reserve portfolio (in RMB terms) independently of the policy course the US and others adopt. the underlying pressure from China’s large current account surplus implies as much. China could have protected itself by lending its savings surplus out in rmb — i.e. refusing to buy $ or euro denominated debt, and thus refusing to take the currency risk. It didn’t, and the US never committed to using monetary policy to maintain the dollar’s external value. Chinese policy makers knew the risks they were taking, and still choose to take them.

    It is now just struggling to accept the costs of that policy, just as the US is struggling to accept the costs of its policy of allowing a host of financial institutions to lever up on the back of an (implicit) government guarantee, an arrangement that let the banks pay themselves very well when markets were rising and stick most of the downside costs to the us taxpayer.

    neither the US nor chinese nor European taxpayer is going to come out of the experiment of allowing massive global and internal imbalances to go unchecked all that well.

  • Posted by bsetser

    Lawrence —

    the PBoC subsidized Chinese exporters, and as a by product bought a lot of treasuries. it never bailed the US out. its treasury purchases rose recently only because it was selling agencies (and perhaps equities), not because it was buying more us debt.

    and in my view, huge chinese inflows helped to create the conditions that led the US gov to need to bailout the financial sector. helped create doesn’t mean caused — only that chinese policy contributed to the permissive financial conditions that led to large bad bets.

  • Posted by entropymin

    Debasement of currency has always been a sign of weakness and desperation, rather than financial sophistication. It is yet another iteration in the vicious cycle of inflation and debasement. Nixon would be proud.

    Instead of snickering over how clever this move is, sticking it to the poor foreign bastards who have no recourse, anyone who cares about this country should despair…

  • Posted by John

    “My guess is that Europe is far more worried by the dollar’s recent slide”

    that is not true. Euro needs to stay above 1.16-1.20 to survive, it’s that simple. Were them worried when the usd was heading down the last 5 years ?

  • Posted by gillies

    capitalism is a very resilient system. put people in gaol and take away all of their money – and they quickly find other ways to trade and keep count of who owes what to whom. cigarette standard. heroin standard.

    since 1971 the dollar and its allies are not a commodity nor a store of value but just a credit note from some controller of pixels, that is trusted because it is trusted.

    printing that fiat currency looks simple, but the maintenance of trust is very complex.

    when the g20 meet in london ( yes, i was wrong – remember i guessed that this bit of history would be made in paris ? ) they will try to agree levels of currency debasement that will ease the pressure on borrowers without triggering fury on the part of the savers and taxpayers.

    jl says : “i dont think it’s a good idea to discuss the topic on this board because of all the conspiracy “nuts” who fail to understand the world’s global imbalances…”

    but the mob who stormed the bastille may not all have had phds in politics and economics, either.

    u s c e os currently earn 350x average workers’ wages. what part of that does anyone not understand ? the g20 will meet against a background of dissent and may be upstaged by street theatre. in democracies ignorance is power.

    if the mob has concluded that they are short changed by a global elite of pixel shufflers who always load the dice against the punters and in favour of the house, might they be tempted to burn down the casino ? and who can blame them ?

    i think that the meeting is being held in london because there is a growing feeling among otherwise disparate nations that we now have to negotiate our way out of ‘dollar hegemony.’ meeting outside of the u s is significant. the next ‘bretton woods” will not be a u s vacation resort – and it definitely won’t be held around a pool in boca raton, florida.

  • Posted by surprised

    i am bit surprised Brad has yet to comment or blog on the prospects for a new global reserve, and it’s indications for the u.s. economy and/or China….

  • Posted by WStroupe

    Indian Investor,

    I think a somewhat weaker dollar is good for the U.S. economy in the sense that it helps U.S. exports. But the U.S. export sector, no matter how vigorous, can’t save a U.S. economy that signed onto the “New Economy” model (asset-based economy)to such a great extent.

    And a steadily declining dollar is bad for U.S. finances and for its financial system itself because it undermines foreign appeal for the dollar as a safe store of wealth. At present, with the huge Treasuries bubble and huge new sums of public debt coming online, that last thing the U.S. needs is to see international appeal for, and confidence in, the dollar get undermined. That would portend that the Fed would have to go to profound lengths to try to replace flagging foreign demand for U.S. debt. And that money creation would not just weaken the dollar, but it would undermine its value, and that would further undermine its international appeal. Then you’d risk having investors stampede out of Treasuries and into whatever asset(s) will become the next bubble.

    The Treasury and Fed are already on that path with their big issuance of new debt and with the Fed starting to buy it up. If this continues, and accelerates, as I think it will, then we’re on the road to undermining the currency, not just declining it to some extent.


    I think it would be more accurate to say that the dollar pegs are under increasing strain because of dollar volatility. Up until last summer, it was dollar weakness, and now it’s dollar strength. The dollar is giving everyone a real roller-coaster ride. It’s losing some appeal due to its wild volatility. Now, with the Fed printing money, it’s likely to swing in the opposite direction (weakness) and its likely to go much further into weakness than is desired, and much too fast than is desired. “Stability” and “dollar” have become antonyms, whereas they used to be synonyms. That’s distinctly unappealing to CBankers around the globe. Also, the weaker dollar reflating the U.S. economy is, to my mind, a bit of a conundrum. Why? Because the U.S. is trying to revive securitization (in other words, revive the asset model economy). I don’t see that happening anytime soon because of the massive cleanup of assets that has to be done (some estimates at more than $10 trillion worth). Unless you think reviving securitization has a chance of miraculously removing the toxicity of these assets? I don’t know. Global confidence in the asset-based model has been so shaken, and assets have been so poisoned. I just don’t know. I’m afraid that while the incredibly costly attempts at revival of securitization are being enacted, the job losses and consumer spending contraction may well become so severe as to nullify any benefits of an attempted revival. Because, the revival attempts rely on ‘trickle down’ in the sense that wealth will supposedly trickle down to consumers, thus lifting the real economy out of recession/depression. I’m dubious that it can do so in the relatively short time required to turn the U.S. around. And I think foreigners like China are getting more and more dubious about this too.

  • Posted by Mark

    US does not need to draw on its reserves because it sells dollar denominated bonds. How does China do it? I infer that they use their current account surplus to fund their fiscal deficit. Is this correct? A little confused…

  • Posted by RebelEconomist


    You repeat this argument again and again on your blog, and it is disingenuous: “the US never committed to using monetary policy to maintain the dollar’s external value. Chinese policy makers knew the risks they were taking, and still choose to take them.”

    It is unlikely that changes in the external value of the dollar could be sufficiently large to generate damaging losses for China without slippage of the internal value of the dollar, and the US do commit to that “stable prices” in the Federal Reserve Act. What is worrying the Chinese is the growing prospect of inflationary repudiation of US debt.

  • Posted by Jeff Benson

    So you’re suggesting a severely weakening dollar and a rise in inflation? I think you’re right. I think that if FCBs holding reserves in dollars begin to diversify away from USD, we’ll be at risk of hyperinflation. I think risk aversion, de-leveraging, re-regulation, and de-globalization will wreak havoc on the dollar.

  • Posted by Jeff Benson

    I should add, take into context the shear magnitude of the hole the Fed and Treasury are trying to fill. I don’t think you can’t resolve a loss of that size with shear monetary policy…or maybe, if you’re willing to compromise foreign trust in your currency, you can.