Monday, March 16, 2009

China Beginning To Use Monetary Leverage On U.S.

While the U.S. has racked up trillions in debt, China has been buying up this U.S. debt. Now China owns more U.S. debt than any other country on the planet, and of course with that comes a great deal of political power over the U.S. China owns so much of our debt that if they were to start selling it off in mass quantity it could collapse our entire financial system. China has not said that they have any intention of doing so, nor would it be financially wise for them to, however, the threat alone carries a lot of weight. One of Obama's campaign claims was that he intended to fight China's monetary manipulation, but with little surprise — after urging from China — the U.S. backed down. Now China is urging the U.S. to be more prudent with their stimulus spending — in order to protect the value of their investment. Kathy Lien dives more into this story in her blog post below.

According to the latest data from Treasury, foreign investors were net sellers of U.S. dollars. The Madoff scandal led to a tremendous amount of liquidation by hedge funds in the Caribbean and Luxembourg but we have our eye on China. The Asian Giant continues to be a net buyer of dollar denominated investments, albeit at an increasingly sluggish pace. For the third month in a row, China has slowed their purchase of U.S. dollars. There are many reasons why their demand for dollars is waning, but don’t expect them to become net sellers of U.S. dollars anytime soon ahead of the Treasury’s report on Currency Manipulation next month.

With a month to go before the report is due for release, China is flexing their muscles. This weekend, Chinese Premier Wen Jiabao signaled to the U.S. that they are fully aware of the power they have on the U.S. economy and how the U.S. needs China just as much as China needs the U.S. He said that “we lent such huge funds to the United States, and of course we’re concerned about the security of our assets.” If China decided that U.S. investments are no longer safe, their liquidation would drive yields significantly higher and stocks significantly lower. The consequences of infuriating China are severe because they have the power to retaliate.

China’s continual accumulation of U.S. Treasuries is also political. With a growing U.S. deficit, there are much better ways for China to spend their money such as investing in resource companies. The sharp decline in Chinese exports also automatically reduce their need to weaken the Yuan by buying U.S. dollars. However for political reasons, the Feb and March TIC data should continue to report that China is a net buyer of U.S. dollars.

CNBC VIDEO: Is US Debt Still Desirable to China?

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1 comment:

Michael J. Bernard said...

Hyperinflation and the crash of the Keynesian model could be in the offing soon if the Chinese drastically draw down.