2018-01-19

Chinese Buying or Not of UST Doesn't Matter

Carnegie: Why China Likely Won’t Buy Fewer U.S. Treasury Bonds
Even if Beijing forced institutions like the People’s Bank of China to purchase fewer U.S. government bonds, such a step cannot credibly be seen as meaningful retaliation against rising trade protectionism in the United States. As I have tried to show, Beijing’s decision would either have no impact at all on the U.S. balance of payments, or it would have a positive impact. It would have almost no impact on U.S. interest rates, except to the extent perhaps of a slight narrowing of credit spreads to balance a slight increase in riskless rates.
Pettis lays out several scenarios, a great antidote to a lot of nonsense in the financial media. Whether China is buying or selling UST because of fundamental economic factors is important, but if they make a political policy decision to not accumulate USTs with dollar inflows, it doesn't mean what most people think it means.

More broadly, too much "pop" analysis only focuses on one possible direction when it comes to China, the USA and the dollar. As I was saying here years ago, if China is selling USTs to prop up the yuan, it will be dollar positive. And that was exactly as it happened from 2014-2016.

A lot of "common widsom" analysis ignores the difference between a lack of buyers and motivated sellers. Most bull markets end because buying power exhausts, not because people decided it was time to sell. Volume declines before the price turns. U.S. trade deficits rise and fall with economic activity for structural reasons. "Make America Great Again" pro-U.S. manufacturing President Trump has sent the U.S. trade deficit near its post-2007 high because economic activity picked up. Even if he's able to structurally reform the economy through trade policy and deregulation, in the short-term the deficit is tied to economic activity. A rising dollar also typically coincides with global weakness and the value of imports declines.

Rising U.S. imports of oil and Chinese goods fuel demand for dollar assets. If U.S. oil production rises and trade policy reduces trade, the overall demand for Treasuries falls along with a falling outflow of dollars. Increased economic activity in the U.S. lifts U.S. tax receipts, inflation and interest rates. If the global economy is expanding as this happens, credit growth will move overseas and some of that credit will flow into U.S. assets, pushing up the exchange rate of the U.S. dollar.

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