Currency Wars_ The Making of the Next Global Crisis - James Rickards [85]
Figures on China’s purchases of U.S. Treasury bonds are difficult to ascertain because China is nontransparent about its holdings. Not every dollar-denominated bond is issued by the U.S. government and not every government security is issued by the Treasury. Many U.S. government securities are issued by Fannie Mae, Freddie Mac and other agencies, and China holds some dollar-denominated bonds issued by banks and others not part of the U.S. government. There is no doubt, however, that the vast majority of China’s dollar holdings are in U.S. Treasury bonds, notes and bills. Official U.S. figures put Chinese holdings of Treasury securities in excess of one trillion dollars, but when government agency securities from Fannie Mae and Freddie Mac are taken into account, the dollar-denominated government securities total is much higher.
China’s great fear is that the United States will devalue its currency through inflation and destroy the value of these Chinese holdings of U.S. debt. There has been much speculation that China, in retaliation for U.S. inflation, could dump its one trillion dollars of U.S. Treasury securities in a highly visible fire sale that would cause U.S. interest rates to skyrocket and the dollar to collapse on foreign exchange markets. This would result in higher mortgage costs and lower home prices in the United States, as well as other major financial dislocations. The fear is also that China could use this financial leverage to sway U.S. policy in areas from Taiwan to North Korea to quantitative easing.
These fears are dismissed by most observers. They say that China would never dump its Treasury securities because it has far too many of them. The Treasury market is deep, but not that deep, and the price of Treasuries would collapse long before more than a small fraction of China’s bonds could be sold. Many of the resulting losses would fall on the Chinese themselves. In effect, dumping Treasuries would mean economic suicide for the Chinese.
This easy logic ignores other things the Chinese can do that are just as damaging to the United States and far less costly to the Chinese. Treasury securities are sold in many maturities, ranging from thirty days to thirty years. The Chinese could shift the mix of their Treasury holdings from longer to shorter maturities without selling a single bond and without reducing their total holdings. As each long-term note matures, China could reinvest in three-month instruments without reducing its total investment in Treasuries. These shorter maturities are less volatile, meaning the Chinese would be less vulnerable to market shocks. This shift would also make the Chinese portfolio more liquid, vastly facilitating a full Chinese exit from Treasury securities. The Chinese would not have to dump anything but merely wait the six months or so it takes the new notes to mature. The effect is like shortening the time on a detonator.
In addition, the Chinese are aggressively diversifying their cash reserve positions away from dollar-denominated instruments of any kind. Again, this does not involve dumping and reinvesting by China, but simply deploying its new reserves in new directions. The Chinese earn several hundred billion dollars each year from their trade surplus. This is a massive amount of new money that needs to be invested alongside the reserves they already have. While existing reserves may remain mostly in U.S. Treasury debt, new reserves can be used in any way that makes sense to the Chinese.
Investment options in other currencies are limited. The Chinese can buy bonds in yen, euros and sterling issued by governments and banks outside the United States, but the choices are few—there simply aren’t enough of them. None of those other markets has the depth and quality of the U.S. Treasury market. But China’s choices are not limited to bonds. The other leading investment—and the one