A Beijing bluff on treasuries?

This article first appeared in The Edge Financial Daily, on January 12, 2018.
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THE Bloomberg News report that senior government officials in Beijing recommended slowing or halting purchases of US Treasuries is encountering a wall of scepticism, and rightly so.

Even China’s State Administration of Foreign Exchange said yesterday that the report “might have cited wrong sources or may be fake news.” There is a third possibility: that Beijing floated a trial balloon to see how the market would react.

To the extent China would have to scoop up incoming dollars to keep the value of the yuan from rising too much too soon, what else can it possibly purchase with those dollars? Treasuries maturing in five years pay 2.32%. If China tries to alter the composition of its US$3.1 trillion (RM12.37 trillion) foreign-exchange war chest by swapping dollars to buy comparable securities denominated in any of the world’s main reserve currencies, it will find German bunds and British gilts paying even less.

Japanese and Swiss bonds offer somewhat higher yields. However, if every central bank in the world had given up on the world’s most liquid security every time it got a half-per cent extra yield somewhere else, the dollar’s share in the world’s known reserves would not have held above 60% for almost a quarter-century. (It is 63.5% now.)

If Beijing wants a bargaining chip in trade tensions with the US, it should look elsewhere.

In 2009, the Chinese central bank did try to diversify away from the dollar. The euro’s share in known global reserves peaked at 28% a few months after Wen Jiabao, the then Chinese premier, said he was “worried” about the huge amount of money his country had lent to the US.

Then he — and the world — got something rather more real to worry about as the European debt crisis became an existential threat to that region’s single currency. According to the most recent data from the International Monetary Fund, the euro’s share in worldwide foreign-exchange reserves is now down to 20% (see chart — Treasuries Reign Because Dollar Is King).

It is hard to accept that the Chinese would want to cause a selloff in Treasuries. Higher Treasury yields would mean tighter financial conditions in the US, crimping demand for Chinese exports. There would be ripple effects. If the world’s least risky securities offered yields much juicier than at present, capital would flow out of emerging-market economies, making it costlier for companies in India, Indonesia, Brazil and South Africa to invest in new factories. That would also hurt Chinese machinery and equipment shipments.

Can China stop accumulating reserves altogether, obviating the need to buy Treasuries or anything else? As long as the nation wants to simultaneously control the yuan’s exchange rate and local interest rates — and do so while keeping its capital markets reasonably open to the world — even that is not a real possibility. The only conclusion is that Beijing must be bluffing. — Bloomberg