Speaking at his annual press conference on Friday, Mr. Wen confessed to feeling nervous about China’s holdings of US dollar assets.
“We have lent a huge amount of money to the United States. Of course we are concerned about the safety of our assets. To be honest, I am a little bit worried,” he admitted.
Most people assumed Mr. Wen is worried about Beijing’s holdings of US Treasury debt, which are estimated to make up as much as US$750 billion of China’s US$1.95 trillion of official foreign exchange reserves.
With the US budget deficit projected to hit a staggering US$1.75 trillion this year, concern is growing that a flood of official debt issues will overwhelm demand, sending the price of Treasury securities into free fall and inflicting massive capital losses on unfortunate investors.
Anxious to calm Mr. Wen’s fears, US officials rushed to reassure China that its holdings are safe.
“The US Treasury market remains the deepest and most liquid market in the world,” said the Treasury Department in a statement.
US President Barack Obama went even further according to the Bloomberg news service, declaring that investors can have “absolute confidence” in Treasury bills.
On the surface, these reassurances appear largely justified. After all, US Treasury debt is already backed by “the full faith and credit” of the US government, and the probability of default is vanishingly small.
On top of that, the market performance of Treasury securities since the outbreak of the credit crisis hardly gives cause for concern. Last year, holders of Treasuries earned handsome double digit returns on the back of safe haven flows into the market. And although prices have slipped a bit over the past couple of months, they remain at elevated levels.
What’s more, it is not clear that heightened issuance will necessarily overwhelm demand, hammering Treasury prices. The increase in spending by the federal government is being partly offset by a sharp rise in saving by US households, much of which is being invested in Treasuries.
But if Treasury debt is relatively secure, Mr. Wen has plenty more to worry about. As Brad Setser at the Council on Foreign Relations in New York points out, Treasury securities make up only around half of China’s US dollar assets.
Beijing also holds around US$500 billion of US government agency debt (see the first chart) issued by bodies like Fannie Mae and Freddie Mac, which are not backed by an explicit government guarantee.
That obviously makes Beijing’s reserve managers nervous. Since last summer, they have cut their holdings of agencies in favour of safer Treasuries.
Yet following last September’s effective takeover of Fannie and Freddie by the federal government, the chances of a default by either agency have dropped almost to zero. As a result, the spreads at which their debt trades over Treasuries have contracted in recent months, despite the sales by Beijing and other reserve managers.
China holds other US dollar assets too. But although rumours abound of massive losses sustained last year by Beijing’s holdings of corporate bonds and equities, Mr. Wen can hardly expect the US government to accept responsibility for the damage.
Of course, what might bother Mr. Wen is not so much concern for the specific assets China holds so much as worries about the currency they are denominated in: the US dollar.
Yet the probability of a US dollar crash in the foreseeable future appears remote. In fact the US dollar has benefited from the crisis, strengthening 20 per cent since last summer against a broad basket of currencies.
And with China keeping the yuan rock steady against the US dollar for the last nine months (see the second chart) as appreciation pressure on the mainland currency has abated, Beijing is in little danger of suffering valuation losses on its US dollar holdings.
So, on the whole, it looks as if Mr. Wen needn’t worry quite so much.
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Wen’s worries over US assets look overdone
Tom Holland
16 March 2009
Premier Wen Jiabao is a worried man.
Speaking at his annual press conference on Friday, Mr. Wen confessed to feeling nervous about China’s holdings of US dollar assets.
“We have lent a huge amount of money to the United States. Of course we are concerned about the safety of our assets. To be honest, I am a little bit worried,” he admitted.
Most people assumed Mr. Wen is worried about Beijing’s holdings of US Treasury debt, which are estimated to make up as much as US$750 billion of China’s US$1.95 trillion of official foreign exchange reserves.
With the US budget deficit projected to hit a staggering US$1.75 trillion this year, concern is growing that a flood of official debt issues will overwhelm demand, sending the price of Treasury securities into free fall and inflicting massive capital losses on unfortunate investors.
Anxious to calm Mr. Wen’s fears, US officials rushed to reassure China that its holdings are safe.
“The US Treasury market remains the deepest and most liquid market in the world,” said the Treasury Department in a statement.
US President Barack Obama went even further according to the Bloomberg news service, declaring that investors can have “absolute confidence” in Treasury bills.
On the surface, these reassurances appear largely justified. After all, US Treasury debt is already backed by “the full faith and credit” of the US government, and the probability of default is vanishingly small.
On top of that, the market performance of Treasury securities since the outbreak of the credit crisis hardly gives cause for concern. Last year, holders of Treasuries earned handsome double digit returns on the back of safe haven flows into the market. And although prices have slipped a bit over the past couple of months, they remain at elevated levels.
What’s more, it is not clear that heightened issuance will necessarily overwhelm demand, hammering Treasury prices. The increase in spending by the federal government is being partly offset by a sharp rise in saving by US households, much of which is being invested in Treasuries.
But if Treasury debt is relatively secure, Mr. Wen has plenty more to worry about. As Brad Setser at the Council on Foreign Relations in New York points out, Treasury securities make up only around half of China’s US dollar assets.
Beijing also holds around US$500 billion of US government agency debt (see the first chart) issued by bodies like Fannie Mae and Freddie Mac, which are not backed by an explicit government guarantee.
That obviously makes Beijing’s reserve managers nervous. Since last summer, they have cut their holdings of agencies in favour of safer Treasuries.
Yet following last September’s effective takeover of Fannie and Freddie by the federal government, the chances of a default by either agency have dropped almost to zero. As a result, the spreads at which their debt trades over Treasuries have contracted in recent months, despite the sales by Beijing and other reserve managers.
China holds other US dollar assets too. But although rumours abound of massive losses sustained last year by Beijing’s holdings of corporate bonds and equities, Mr. Wen can hardly expect the US government to accept responsibility for the damage.
Of course, what might bother Mr. Wen is not so much concern for the specific assets China holds so much as worries about the currency they are denominated in: the US dollar.
Yet the probability of a US dollar crash in the foreseeable future appears remote. In fact the US dollar has benefited from the crisis, strengthening 20 per cent since last summer against a broad basket of currencies.
And with China keeping the yuan rock steady against the US dollar for the last nine months (see the second chart) as appreciation pressure on the mainland currency has abated, Beijing is in little danger of suffering valuation losses on its US dollar holdings.
So, on the whole, it looks as if Mr. Wen needn’t worry quite so much.
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