[DEBATE] : China said to need guarantees for Treasuries

[Riaz K Tayob]

China said to need guarantees for Treasuries

By Belinda Cao and Judy Chen
Bloomberg News
Wednesday, February 11, 2009

http://www.bloomberg.com/apps/news?pid=20601087&sid=aXWQEydhsoUI&

BEIJING -- China should seek guarantees that its $682 billion holdings 
of U.S. government debt won't be eroded by "reckless policies," said Yu 
Yongding, a former adviser to the central bank.

The U.S. "should make the Chinese feel confident that the value of the 
assets at least will not be eroded in a significant way," Yu, who now 
heads the World Economics and Politics Institute at the Chinese Academy 
of Social Sciences, said in response to e-mailed questions yesterday 
from Beijing. He declined to elaborate on the assurances needed by 
China, the biggest foreign holder of U.S. government debt.

Benchmark 10-year Treasury yields climbed above 3 percent this week on 
speculation the government will increase borrowing as President Barack 
Obama pushes his $838 billion stimulus package through Congress. Premier 
Wen Jiabao said last month his government's strategy for investing would 
focus on safeguarding the value of China's $1.95 trillion foreign reserves.

China may voice its concerns over U.S. government finances and the 
potential for a weaker dollar when Secretary of State Hillary Clinton 
visits China on Feb. 20, according to He Zhicheng, an economist at 
Agricultural Bank of China, the nation's third-largest lender by assets. 
A People's Bank of China official, who didn't wish to be identified, 
declined to comment on the telephone.

"In talks with Clinton, China will ask for a guarantee that the U.S. 
will support the dollar's exchange rate and make sure China's 
dollar-denominated assets are safe," He said in Beijing. "That would be 
one of the prerequisites for more purchases."

Chinese Foreign Ministry Spokeswoman Jiang Yu said yesterday that talks 
with Clinton would cover bilateral relations, the financial crisis, and 
international affairs, according to the Xinhua news agency.

U.S. government bonds returned 14 percent last year including price 
gains and reinvested interest, the most since rallying 18.5 percent in 
1995, according to indexes compiled by Merrill Lynch & Co. Concern that 
the flood of bonds would overwhelm demand caused Treasuries to lose 3.08 
percent in January, the steepest drop in almost five years, Merrill data 
show. The yield on the benchmark 10-year U.S. Treasury has risen to 2.80 
percent from 2.21 percent at the end of last year.

China’s loss of more than $5 billion from investing $10.5 billion of 
its reserves in New York-based Blackstone Group LP, Morgan Stanley, and 
TPG Inc. since mid-2007 may increase its demand for the relative safety 
of Treasuries.

"The government will be a net buyer of Treasuries in the short term 
because there's no sign they have changed their strategy," said Zhang 
Ming, secretary general of international finance research center at the 
Chinese Academy of Social Sciences in Beijing. "But personally, I don't 
think we should increase holdings because the medium- and long-term 
risks are quite high."

Bill Gross, co-chief investment officer of Pacific Investment Management 
Co., said on Feb. 5 the Federal Reserve will have to buy Treasuries to 
curb yields as debt sales increase. U.S. central bank officials said 
Jan. 28 they were "prepared" to buy longer-term Treasuries.

"The biggest concern for China to continue buying U.S. Treasuries is 
that if Obama's stimulus doesn't work out as expected, the Fed may have 
to print money to cover the deficit," said Shen Jianguang, a Hong 
Kong-based economist at China International Capital Corp., partly owned 
by Morgan Stanley. "That will cause a dollar slump and the U.S. 
government debt will lose its allure for being a safe haven for 
international investors."

China's foreign-exchange reserves, the world's biggest, grew about $40 
billion in the fourth quarter, the smallest expansion since mid-2004 as 
an end to yuan appreciation since July prompted investors to pull money out.

The world's third-biggest economy grew 6.8 percent in the fourth 
quarter, the slowest pace in seven years. Policymakers cut interest 
rates by the most in 11 years and announced a 4 trillion yuan ($585 
billion) economic stimulus plan in November to spur domestic demand.

Yu said China won't channel its reserves toward stimulating the economy 
because its trade surplus is sufficient to fund any import needs. 
China's trade surplus was $39 billion in December, the second-largest on 
record.

A decline in reserves "isn't likely because of China's huge twin 
surpluses," Yu said. China "should diversify its reserves away from U.S. 
Treasuries if the value of China's foreign-exchange reserves is in 
danger of being inflated away by the U.S. government's pump-priming," he 
said.

China may try to link trade and currency policy disputes to its future 
investment in Treasuries, said Lu Zhengwei, an economist in Shanghai at 
Industrial Bank Co., a Chinese lender partly owned by a unit of HSBC 
Holdings Plc.

U.S. Treasury Secretary Timothy Geithner accused China on Jan. 22 of 
"manipulating" the yuan to give an unfair advantage to its exporters in 
the global market. The currency has dropped 0.16 percent since the start 
of this year to 6.8342 per dollar, following a 21 percent gain since a 
peg against the dollar was abandoned in July 2005.

"China can also use this opportunity to get a promise from the U.S. not 
to make inappropriate requests on bilateral trade and the Chinese yuan," 
Lu said. "We can't afford more yuan appreciation as the economy is 
facing a serious slowdown."