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Friday, January 06, 2006

China Is Going To Call In Its Loans!!!

Here is where the fears are proven right or wrong: The Financial Times reports that China is diversifying its investments.

China indicated on Thursday it could begin to diversify its rapidly growing foreign exchange reserves away from the US dollar and government bonds – a potential shift with significant implications for global financial and commodity markets.

Economists estimate that more that 70 per cent of the reserves are invested in US dollar assets, which has helped to sustain the recent large US deficits. If China were to stop acquiring such a large proportion of dollars with its reserves – currently accumulating at about $15bn (€12.4bn) a month – it could put heavy downward pressure on the greenback.

The public statement was light on particulars. Reports Financial Times:

The announcement came from the State Administration of Foreign Exchange (Safe). It gave no more details about whether this meant a big shift in the investment strategy for Chinese reserves, which according to local press reports reached nearly $800bn at the end of last year and are expected by economists to near $1,000bn this year.

This was reported as likely since July, 2005 in the CHINAdaily.com. I'd hold off from jumping from the 14th floor just yet. We will see what the paring down will actually be.

Adds Mike Taylor:

Let’s say that China dumps US debt… what will happen to the interest rate on American debt?

China holds about 12% of all outstanding US debt (http://www.treas.gov/tic/mfh.txt), roughly $248 billion. Let’s say they dump it all, who do they dump it on?

Someone has to BUY that debt from China… remember that a marketplace is made up of a buyer and seller that agree on a price that is beneficial to both.

There is tremendous daily trading volume on US debt that happens every day, potential buyers of the dumped US debt would have a choice to make: Do I buy this US debt at a certain interest rate/risk or do I buy another country’s debt at a certain interest rate/risk?

Although the Chinese are offering a LOT of US debt, they still have to make an attractive price to foreign buyers by lowering the price of the underlying security and thereby raising the effective interest rate. This means the Chinese would have to take LESS for the US debt they hold than it is actually WORTH… a bad deal for the Chinese… they lose money. The US debt is priced by the marketplace and is determined by the economic performance of the United States vis-à-vis other countries… the price isn’t determined by whether the Chinese like US debt, dislike George Bush or have a toothache that day.

Short-term, the amount of US debt on the market will cause the interest rate to rise on new debt issues coming out of United States… but long-term the interest rates are set by the marketplace of all foreign debt. Some economists estimate that about 12 other countries would have to raise their debt interest rates simultaneously to affect the rate offer on new debt coming from the United State.

What is the probability that 12 nations will get together and raise their rates…in effect shelling out billions of their currency for no other reason than the Chinese want to get back at the US? Practically zero.

So if you’re the Chinese government, you have to ask yourself, do you feel lucky? Well… do you, punk?!?

-- Mike


At 7:31 AM, Blogger francois said...

Turns out this was just a bluff. After it scared no one except the always bearish on America liberal crowd.

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