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I am pretty sure China didn’t sell Treasuries in April (or May, for that matter)

by Brad Setser
June 19, 2009

The fall in China’s recorded Treasury holdings in April has attracted a fair amount of attention. Too much, in my view. Best that I can tell, China shifted from bills to short-dated notes in April rather than actually reducing its overall Treasury portfolio. It just so happens that China buys all its short-term bills in ways that show up in the US TIC data, but only a fraction of its longer-term notes in ways that show up in the US TIC data. A shift from bills to notes then could register in the US data as a fall in China’s total Treasury holdings and a rise in the UK’s holdings.

This is actually a well established pattern. The past five surveys of foreign portfolio investment in the US have all revised China’s long-term Treasury holdings up (in some cases quite significantly) even as they revised the UK’s holdings down. The following graph shows the gap between Chinese long-term Treasury purchases in the TIC data and China’s actual purchases of long-term Treasuries– as revealed in the survey. With the help of Arpana Pandey, I have smoothed out the impact of the survey revisions. But when there is a hard data point — say June 2006 — the y/y increase in China’s Treasury holdings in the adjusted series should match the increase in the survey.

china-april-tic

The last survey data point though comes from June 2008, so the subsequently data includes some estimates — specifically estimates of the share of the UK’s Treasury purchases that should be attributed to China. I am pretty confident though that it is no more inaccurate than the published US TIC data, which systematically under counted Chinese purchases of long-term bonds over the last five years

Here are three signs to watch to know when China really is reducing its US holdings.

First, the TIC data should show a fall in China’s holdings, i.e. net sales of Treasuries.

Second, the TIC data should also show limited purchases of Treasuries through the UK. The fall in China’s holdings should not be offset by a rise in the UK’s holdings.*

Third, the Fed’s custodial holdings should not be rising at a strong clip — as, given China’s size, it is hard to see how China doesn’t make up a large fraction of all custodial holdings. Mathematically, it is impossibe for China not to be largest holder of Agencies at the New York Fed, and it is hard to see why it wouldn’t also hold a decent chunk of its Treasuries there.

In April, only one of those three things happened. China’s recorded holdings fell. In my book, that doesn’t meet Accrued interests’ call for “hard evidence” that China actually is reducing its holdings. Not when there were also large purchases of notes through the UK, and in the past much of that flow has ultimately been reattributed to China. And not when there was a fairly strong rise in the Fed’s custodial holdings.

The best explanation for that combination of facts is that China was shifting a small fraction of its portfolio out of bills (hence the fall in it bill holdings) and into short-term Treasury notes (hence the rise in direct Chinese note purchase and UK note purchases).

The TIC data for China has too many problems to be taken at face value. Just using the unadjusted TIC flow data — the kind that is often downloaded from Bloomberg — to estimate China’s total purchases of US assets produces a result that doesn’t match the revised data in the United States final balance of payments data. Nor does it match the known stock of Chinese holdings, which gets bumped up when the survey data is released.

To be sure, the pace of growth in China’s overall US portfolio has slowed. That certainly reflects China’s decision to lend more money to a host of commodity exporters — and its decision to stockpile key commodities. That has cut into the funds available to invest in the US.

And the pace of growth in China’s Treasury portfolio has also slowed.

But that is to be expected. Much of the growth in China’s portfolio, and indeed much of the overall growth in central banks Treasury holdings, over the past year has reflected a shift out of risk assets. Central bank purchases of Treasuries have actually been running far above total global reserve growth for the last couple of quarters. That cannot last forever.

china-april-tic-2-imf-and-bea1

Some reduction in the pace of inflows into the Treasury market was always to be expected if reserve growth didn’t pick back up.

But the data on reserve growth in the chart is also a bit out of data, as the IMF has yet to release data for q1 — and the end of q2 is now drawing near. Reserve growth likely remained weak in q1 09, but seems to have picked up in q2. That could support a more sustainable inflow into the Treasury market —

At least if major governments remain adverse to credit and equity market risk. That though may also be changing. At least the China Investment Corporation is once again taking risks. Lou ji-Wei is apparently worried about missing ‘opportunities near the bottom of the market.”

The CIC was actually quite conservative in 2008, no doubt in reaction to its losses on its high profile 2007 investments. SAFE took on far more risk. Now it seems that roles may have reversed once again. The overarching reality about China is that it now has so much money that it can now do a little bit (or even a lot) of almost everything.

* The US only tracks the initial sale of a bond to an investor abroad. Subsequent sales never into the TIC data, though they are often picked up in the annual survey.

33 Comments

  • Posted by Bernardo A
  • Posted by Brick

    When you say “Central bank purchases of Treasuries have actually been running far above total global reserve growth for the last couple of quarters. That cannot last forever.” That could be quite worrisome. The conclusion options seem to be either that the global reserve growth will pick up, US consumer savings will support treasuries for a while or some debt will need to be monetized.
    My concern is that we are misreading what is happening in China and that perhaps the stimulus through relaxing bank lending rules is uneven. Chief Economist Shen Minggao contends that where credit provided to state owned entities is increasing the opposite is happening to small business. While this might be a desirable outcome from China’s point of view and the long term stability of the world economy it poses some risk in terms of short term flows of money.

  • Posted by DJC

    China State Media: Chinese PBoC lowers holdings in US government bonds

    BEIJING (AFP) — A decision by China to reduce its US Treasury holdings suggests concern about the US attitude towards its economic woes, Chinese economists were quoted as saying in state media Wednesday.

    The remarks, coming after US data showed a modest decline in Chinese investments in US government bonds, were in contrast to an earlier statement in Beijing which had said the recent sell-off was a routine transaction.

    “China is implying to the US, more or less, that it should adopt a more pragmatic and responsible attitude to maintain the stability of the dollar,” He Maochun, a political scientist at Tsinghua University, told the Global Times.

    According to US Treasury data issued Monday, Beijing owned 763.5 billion dollars in US securities in April, down from 767.9 billion dollars in March.

    It was the first month since June 2008 that Beijing failed to purchase more US T-bills.

    Zhang Bin, a researcher at the Chinese Academy of Social Sciences, said China’s move showed a more cautious attitude.

    “It is unclear whether the reduction will continue because the amount is so small. But the cut signals caution of governments or institutions toward US Treasury bonds,” Zhang told Xinhua news agency.

  • Posted by DJC

    The ‘Buy Chinese’ Trade Dispute
    Vivian Wai-yin Kwok, 06.18.09, 09:25 AM EDT

    It’s official: China wants to shut foreign companies out of its 4-trillion-yuan ($586 billion) economic stimulus package. The “Buy Chinese” command laid down publicly by top planners in Beijing will unavoidably intensify the tension between China and the United States.

    Before a potential trade war between China and the United States, the state media this week fired back at criticism from the Western press aimed at the “Buy Chinese” policy. In an article titled “Balance tilts in favor of local firms,” China Daily defended Beijing’s latest policy, which essentially banned local authorities from granting government contracts within its stimulus package to foreign companies, as a reasonable response to “rising protests about too many fat contracts being awarded to foreign companies.”

    China’s top economic planner, the National Development and Reform Commission, and eight other ministries, jointly released a notice on June 4 to re-enforce government procurement to use only Chinese products or services unless they were not available within the country or could not be bought on reasonable commercial or legal terms.

    http://www.forbes.com/2009/06/18/china-trade-conflicts-markets-economy-wto.html

  • Posted by yoda

    $USB (30 yr bond) setting up sucker bounce and sell hard into 2010? expecting yield to shoot up into 2010. brutal, better short treasury into this bounce.

  • Posted by bsetser

    I like Zhang Bin, but i think he is misreading the April data. As I have noted in the past, the puzzle from 04-08 was that china’s recorded purchases of us assets were way lower than one would expect based on its reserve data. the answer is that you need to look at the tic data for london and hk as well as china itself to see what china is doing (imperfectly).

    Brick — where exactly do you see the near-term risks?

  • Posted by Cedric Regula

    Brick:”The conclusion options seem to be either that the global reserve growth will pick up, US consumer savings will support treasuries for a while or some debt will need to be monetized”

    Ya, lets pick them off, one by one.

    1)”global reserve growth will pick up”

    HaHa. That’s a funny one. The two main sources of reserve growth are China and the oil producers. At the moment we are trying to figure out which side of zero China lies on. The US trade deficit is way down, indicating the loop has contracted.

    It’s widely thought that on average the oil producers need oil prices north of $60-$70 in order to accumulate excess reserves.

    So much for reserve growth.

    2)”US consumer savings will support treasuries for a while”

    Nearly as funny. Take the average household income of $60K times a 5% savings rate. $3000. But the data says average household credit card and “other revolving debt” (this may mean HEWs , I’m not sure) is $8800 per household. So on average they need to reduce the 12% debt before lending at 1%-4%.

    3)”some debt will need to be monetized”.
    Sounding more plausible all the time. The $300B of QE announced by the Fed so far is set to be spent by October. Many have predicted that is just a first installment and the Fed will announce more for the following USG fiscal year.

    There is an option 4. The USG could entice US investors to invest more of the $50 Trillion in US personal net worth into treasuries. That would entail some rebalancing of the more liquid parts other than home equity.

    But the USG would have to convince US investors that treasuries are a good investment. So far they say they don’t want to do that. So I guess that means we are back to monetizing the debt. Go figure. Hope the Chinese and OPEC aren’t listening.

  • Posted by Bonesetter Brown

    Cedric,

    For your option 4, the USG only needs to convince investors that treasuries are better than other alternatives. That could happen even with lower yields.

  • Posted by Cedric Regula

    Bonesetter Brown

    Certainly true, and it has happened recently. ZIRP in a t-bill was better than a US and EM stock market crash, We had maybe a 5% drop in CPI yoy, tho that was after a 6% rise. Forecast is maybe another 1% over the next year. That makes a 30 year treasury at 4.5% sound not to bad at the moment.

    But ever since March when the Fed concurrently announced QE and Green Shoots, US stocks, EM stocks and bonds, commodities and US corp bonds have been on a tear.

    But at some point we have to get to a less exciting, more sustainable trading range in all these things. Annual money printing and treasury bond printing doesn’t seem like the formula.

  • Posted by DJC.

    From Wall Street Journal, Preference for Sons in China creates Economic Bubbles in U.S. (Another stupid Western Neo-liberal Economic theory from idiot Economists – DJC)

    http://blogs.wsj.com/chinajournal/2009/06/18/preference-for-sons-in-china-may-lead-to-bubbles-in-us/

    Through the first half of this decade, America bought far more than it produced, running up an a massive tab with its trading counterparts. In an effort to explain why this had happened, then-Fed governor Ben Bernanke in 2005 identified a “Chinese savings glut.” Developing countries – China in particular – were saving more. Those savings were getting put into long-term debt, pushing interest rates lower.

    In 2007, Chinese household savings as a share of disposable income was 30%, up from 16% in 1990. One possible reason for the jump in savings: The dearth of women is making China’s marriage market extremely competitive, and families with boys are accumulating wealth to make their sons more attractive matches.

  • Posted by charley

    The real question is: did they buy any? And, if no, how long can either country go with that situation?

  • Posted by bsetser

    i was being cautious; my best guess is that it bought a few. and i worry a lot less about net sales of bills than the absence of any bid for longer term notes. the big news to me was that china (and other buying via the uk) inched back into longer dated treasuries.

  • Posted by Yoda

    http://www.chartoftheday.com/20090619.htm?T

    deflation my ass, sure DOW is being deflated by weakening dollar due to FED’s QE.

  • Posted by yoda

    why people from China and Japan think buying dollars or dollar denominated asset can help them to build wealth is beyond me. they have themselves to blame for their destruction of wealth as dollar and USA weaken due to massive debt.

  • Posted by Twofish

    Something that you need to be careful about is read some Chinese person say something in the news media, and thens assume things about what the people making decisions think and do that may not be accurate. Anyone that really is in a policy making policy in either China or the United States is not going to be making off-handed comments to the press, and anyone that gets quoted in the press is obviously not in a policy making position.

    So when you read something that says Chinese person says X about Chinese policy, it’s like reading something that says that Paul Krugman, Brad Delong, or Brad Setser says X about American policy. It may be part of an internal debate, but if the Chinese government wants to do something they won’t talk about it, they’ll just do it.

  • Posted by Twofish

    DJC: The “Buy Chinese” command laid down publicly by top planners in Beijing will unavoidably intensify the tension between China and the United States.

    No it won’t. The US will agree not to complain about “Buy Chinese” and China will agree not to complain about “Buy American.”

    DJC: The state media this week fired back at criticism from the Western press aimed at the “Buy Chinese” policy. In an article titled “Balance tilts in favor of local firms,” China Daily defended Beijing’s latest policy,

    Referring to Chinese newspapers as “state media” misses how the Chinese press system works. Basically there is no reason to think that an article the China Daily reflects official policy any more than an article in the New York Times. If the Chinese government issues an order that newspapers take a particular line, then it’s obvious because *every* Chinese newspaper is going to have the same editorial.

    You aren’t going to see any “free Tibet” editorials in a PRC newspaper, but on economic issues, the media can print what they want as long as they don’t criticize the Communist Party. If the Party has made a decision to do something, they everyone has to shut up, but on things like trade policy or RMB appreciation, the Party allows pretty free discussion, since it doesn’t quite know what it should do.

  • Posted by guest

    Nice grphs

    In reality, the credit market shutdown actually gained tremendous momentum in the first quarter. And although it’s natural to expect some temporary stabilization from the government’s massive interventions, the first quarter was SO bad, it’s impossible for me to imagine any scenario in which the crisis could be declared “over.”

    Here are the facts:

    We witnessed one of the biggest collapses of all time in “open market paper” — mostly short-term credit provided to finance mortgages, auto loans, and other businesses. Instead of growing as it had in almost every prior quarter in history, it collapsed at the annual rate of $662.5 billion. (See line 2.)

    Banks lending went into the toilet. Even in the fourth quarter, when the meltdown struck, banks were still growing their loan portfolios at an annual pace of $839.7 billion. But in the first quarter, they did far more than just cut back on new lending. They actually took in loan repayments (or called in existing loans) at a much faster pace than they extended new ones! They literally pulled out of the credit markets at the astonishing pace of $856.4 billion per year, their biggest cutback of all time (line 7).

    Meanwhile, nonbank lenders (line 8) pulled out at the annual rate of $468 billion, also the worst on record.

    Mortgage lenders (line 9) pulled out for a third straight month. (Their worst on record was in the prior quarter.)

    And consumers (line 10) were shoved out of the market for credit at the annual pace of $90.7 billion, the worst on record.

    The ONLY major player still borrowing money in big amounts was the United States Treasury Department (line 3), sopping up $1,442.8 billion of the credit available — and leaving LESS than nothing for the private sector as a whole.

  • Posted by yoda

    market determine everything, looking at charts of $USD, $USB, where is going, DOWN and hitting pivotal point. If FED continues QE, it will break all sort of yield related securities.

  • Posted by Brick

    My short term concern is about the relative size of treasury issuance for fiscal deficit to the shrinking size of the treasury market as a whole. If china is rebalancing and the trade surplus shrinks for china then the size of the US treasury market related to the trade deficit shrinks. The risk is that china begins to rebalance quicker than the US can get back on its feet.
    The reality might be that the stimulus in china may have an unsustainable aspect to it, so the likelihood of the risk may be somewhat moot. Buying of treasuries for US saving might also come into the equation mitigating the risk. I do think it was right for the FED to warn about letting the fiscal deficit get out of hand though.

  • Posted by Rien Huizer

    Twofish,

    Great comments!

  • Posted by Indian Investor

    Dr. Setser, From your previous post i think we agreed that overall, China had just about the same amount of treasuries at the end of April as they had before. My understanding is that they would have had an inflow of dollars on several counts – their exports to the US, and exports to other countries realized in USD. Plus inflows of foreign investment.They had outflows through buying crude, other commodities and perhaps gold.Plus outflows through loans to foreign entities denominated in USD, and outflows from their foreign investments. Traditionally, China had a net accmulation of Treasuries to maintain their dollar peg, despite these flows. In April, they were able to maintain their peg, handle the sum total of these flows, and yet not accumulate more Treasuries. Something has changed drastically.
    On the goods side, lower exports to the rest of the world due to lower aggregate demand should generate lesser inflows of dollars to China. There should be higher inflows of foreign investment to China as a result of the effectiveness of stimulus there. These two factors have been opposite for some time. Their forex outflows have increased, not decreased. Perhaps they stepped up their commodity buys in April. Or perhaps they aren’t receiving payment in USD for some of their traditional exports. Do you have any explanation for what changed, and allowed China to maintain its dollar peg, without accumulating more Treasuries?

  • Posted by Cedric Regula

    Indian:

    I’ve been wondering the same thing. The simplist explanation is they are just leaving dollars in the PBoC bank vault (or computer) in China.

    They don’t do a true FX traded peg. The peg is really just telling those internal to China what the PBoC says the official exchange rate is.

    But why and for how long are good questions.

  • Posted by yoda
  • Posted by Indian Investor

    Cedric – thanks for the reply. I could be wrong but my perception is that imports to the US are paid for by cheque drawn on a US bank. The Chinese exporter then deposits the cheque in an RMB bank account, and the Chinese bank converts the currency at the going rate through a money changer, or the same bank’s forex department/branch. The US Bank’s electronic credit is now with the Chinese bank’s forex department, and the Chinese bank has given a corresponding electronic credit to the Chinese exporter. Forex trading is done based on the electronic credit received by the forex branch/trading desk. Perhaps the PBoC uses the Chinese government funding to provide a credit to the Chinese bank in RMB when it buys dollars from its forex branch. The electronic credit received by the PBoC in dollars from the Chinese bank/money changer is of no use to it directly. Since the PBoC is the local central bank, they are the banker’s banker, and they don’t need to increase the outstanding RMB reserves in their banking system this way. So I think the PBoC just uses the dollar credit to buy Treasuries, or other dollar denominated GSE securities, foreign stocks, etc.
    When PBoC reduces its intervention, they just buy a lower volume of dollar credits from their banking system in exchange for more RMB reserves to the banks. Suppose the PBoC just keeps an electronic dollar credit in its books, and increases the outstanding RMB credits to its banks – that doesn’t make sense to me.

  • Posted by Twofish

    Indian Investor: Do you have any explanation for what changed, and allowed China to maintain its dollar peg, without accumulating more Treasuries?

    Yes. There has been an increase in savings rates in the United States and a general flight to quality, and this increases the demand for the US dollar, which means that China has to buy fewer Treasuries to maintain the peg.

    Indian Investor: The Chinese exporter then deposits the cheque in an RMB bank account, and the Chinese bank converts the currency at the going rate through a money changer, or the same bank’s forex department/branch.

    What you are missing here is how the “going rate” is determined. The PBC targets a value that they want the exchange rate to be, and then they buy or sell enough dollars to keep that exchange rate. If there is an increase in demand for dollars outside of the PBC, they have to buy fewer dollars to maintain their target rate.

  • Posted by Twofish

    Cedric: They don’t do a true FX traded peg. The peg is really just telling those internal to China what the PBoC says the official exchange rate is.

    Yes they do. The quasi-peg that the PBC maintains is a true FX traded peg. It’s not a currency board system, but to maintain the peg, the PBC has to conduct market operations.

    Administrative pegs have *huge* problems, one of which is that it creates a black market, and the PBC abolished administrative pegging in 1993.

  • Posted by jonathan

    Loved the COFER graph. Would be neat to see that versus totals.

  • Posted by Cedric Regula

    Indian:

    Ya, I think Chinese companies deposit dollars at state banks, then the PBoC prints RMB to trade for Dollars with the state banking system. The PBoC states what the exchange rate is. Then they sell sterilization bonds and increase state bank reserve requirements.

    They do some small scale things with Forex, but probably just enough so tourists can get some RMB before heading to China on vacation.

    Here’s an article from 2005 talking about the scale of Chinese participation in FX.

    http://english.peopledaily.com.cn/200505/19/eng20050519_185745.html

  • Posted by guest

    So,it seems that we are all in agreement the private sector is vanishing when the public sector is becoming larger as a lender and borrower of last resort.
    Interest rates have proved themselves,to be an ill device(as much for Keynes)
    Money supply has still to be back tested.

  • Posted by Indian Investor

    Cedric/Twofish: Thanks for your analysis. I see this as a situation where China’s treasuries are being more widely disbursed, to suppliers of commodities, crude, gold, etc. China has found ways to reduce their stock of Treasuries in ways that don’t create a corresponding demand for RMB. Secondly China is very slowly creating a situation where China’s exports don’t lead to increased supply of USD against RMB, i.e. through currency swaps in small volumes, selective settlement of trade in RMB, etc.
    At the same time, China is able to ensure the stability of the dollar peg. This situation, according to me, leaves the US with no option but to borrow in a foreign currency denomination, and, if possible, to borrow less from foreign countries than currently planned.

  • Posted by Twofish

    Cedric: The PBoC states what the exchange rate is. Then they sell sterilization bonds and increase state bank reserve requirements.
    They do some small scale things with Forex, but probably just enough so tourists can get some RMB before heading to China on vacation.

    This is false. If you try to set the foreign exchange rate through administrative means, you end up with thousands of people on street corners offering to change money for you, and you haven’t had this happen in China since the mid-1990′s.

    I’m not sure what the People’s Daily article is referring to, but Chinese involvement in foreign exchange is not small since pretty much every trade transaction involves some currency exchange, and China has had swap centers to trade currency since at least the early 1990′s.

  • Posted by Twofish

    Indian Investor: China has found ways to reduce their stock of Treasuries in ways that don’t create a corresponding demand for RMB.

    I don’t think so. None of what is happening is “planned” by the Chinese government, and they are just reacting to events.

    The interesting thing to look at is “errors and omissions”. That’s the difference between the trade balance and the increase in treasury reserves. For most of the last few years, it’s been positive, but it looks like it has turned sharply negative.

  • Posted by CB

    Hey Brad,

    Where did you get the data for the green line in the first graph? I have looked at the survey that you are referring to (I think it is: http://www.ustreas.gov/tic/shla2008r.pdf), but that doesn’t show monthly data. What data did you take out of the survey to adjust your graph? Also, how do you know how much the U.K. is selling to China?

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