Page 3 of
3 Careful what you wish for, China may grant
it By Julian Delasantellis
process of setting up its own SWF,
which reportedly will be funded with some $300
billion of reserves.
And that's $300
billion that will not make its way into the market
for Treasury securities.
In my March 24,
2006, article US living on borrowed time - and
money, I introduced readers to the US
Treasury's monthly TIC (Treasury International
Capital) report, the data that enumerate
just
how much foreign capital the US is importing every
month to finance its extravagant lifestyle. During
much of 2005, the US was net-importing more than
$100 billion of investment capital every month,
but the bottom line net number is falling sharply;
last December, the US actually failed to attract
any capital at all.
One TIC data set of
particular interest to bond players is just how
great the investment in US government securities
by foreign governments is each month. These
numbers are the core of the flows that constitute
Bretton Woods 2, for they derive mostly from US
dollar reserves held at foreign central banks.
They've been falling, too. From averaging
more than $6 billion a month in 2006, foreign
government purchases of US Treasury have fallen to
average just over $1 billion a month for the first
four months of 2007.
It is of course far
from coincidental that, when US Treasury 10-year
notes were at their lows in yield, in mid-2005,
TIC data were showing foreign flows into
Treasuries at their highest. The central reality
of the bond market is that the yield of bonds
traded in it go down as more people buy them; more
important for the current moment, yields go up as
fewer people buy them.
If China has
sharply curtailed its US Treasury purchases,
unless other buyers step up to the plate, then
Treasury securities prices have nowhere to go but
down, and yields have nowhere to go but up - just
as they have recently.
The US Treasury
will not release May TIC data until mid-July, but
there are indications that suggest that is
precisely what is happening here. A recent
Treasury auction of new 10-year notes had the
lowest rate of foreign government purchase
participation in years. On some financial trader
blogs it is being noticed that, on many days
during the current market rout, the US Treasury
market has opened, at 8:20am New York Time (when
the Treasury futures markets open in Chicago),
with large order imbalances to the sell side.
The speculation here is that this results
from Chinese sellers putting in big sell orders
before they retire for the night (Shanghai time is
12 hours ahead of New York) so they can see
whether, or how significantly, their orders moved
the market.
Of particular significance to
the future is the connection between SWFs and
interest rates. On May 21, China's still-nascent
SWF announced its first prospective investment; it
was going to take a $3 billion stake in the
upcoming initial public offering of the Blackstone
Group, the huge US private equity buyout firm (I
wrote about the current mania for private equity
in my February 22 article The highs and lows of
buyouts). It was after that
announcement that the fiercest selling befell the
world's Treasury markets, as if traders suddenly
realized that the long-feared prospect of Asian
central banks abandoning bonds for other
investments was finally coming true.
World
equity markets stuttered a bit in the face of the
world bond selloff, but they soon recovered their
footing and are once again moving up. That should
not be surprising; if SWFs are about to pounce on
the world's stock markets, that will be
unquestionably good news for share prices.
But will it be too much of a good thing?
Even with buying support from SWFs, can world
stock markets appreciate much further in the face
of rising bond yields? Or would continued
equity-market appreciation in the face of rising
bond yields be prima facie evidence of what
Alan Greenspan once called irrational exuberance?
Right now the only world stock market that Chinese
prosperity is supporting is the Shanghai Stock
Exchange A-share exchange.
That market has
tripled in 14 months, and academic economists the
world over are frightened that when this
speculative bubble finally bursts, as all
speculative bubbles must inevitably do, it will
take the world's economy with it. Specifically,
with so many ordinary Chinese citizens playing the
Shanghai market like a never-losing roulette
wheel, will the Chinese government feel threatened
by the rapid destruction of domestic wealth that a
burst stock market would cause? Will they try to
support the shares with reserves, either from the
People's Bank of China or from its SWF? What will
that do to the investments in the West that the
reserves had been supporting?
A more
frightening prospect is if non-China stock markets
start acting like Shanghai - if SWF money starts
supporting or, more likely, deluging them. Trading
volumes in Shanghai are still small enough,
compared with Western equity markets, that the
Chinese government probably could backstop a
Shanghai crash, but if the world's other stock
markets, supported by Asian SWF money, start
replicating Shanghai's parabolic, meteoric rise,
then all the reserves, tea, or anything else in
China will not be sufficient to support them when
their towers finally topple.
This decade's
boom started in China. Will it end there too?
Will the economic historians of the
future, when tracking back to ascertain the cause
of the world crash of 2007, find that the dominoes
were put in motion when George W Bush started
urging the Chinese to buy more American stuff, and
the Chinese responded with purchases of US
companies and stocks?
Like the Sorcerer's
Apprentice of legend, perhaps it would have been
better if, while an business-administration
graduate student at Harvard in the early 1970s,
the future president would have actually read the
instructions on how to run the world economy.
Julian Delasantellis is a
management consultant, private investor and
educator in international business in the US state
of Washington. He can be reached at
juliandelasantellis@yahoo.com.
(Copyright
2007 Asia Times Online Ltd. All rights reserved.
Please contact us about sales, syndication and republishing.)
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
