Friday, January 3, 2014

China's exorbitant privilege?

There have been reports in the last two years that the central banks (or in some cases SWFs) of Japan, Indonesia, South Korea, Norway, and Australia are investing or are considering investing in Chinese govt bonds (CGBs? PBoCGBs?).  Now it is South Africa's turn.  Given that US Treasuries make up a large majority of current bond holdings, one can assume it is US debt being sold to fund the purchases of Chinese GBs.  Assuming China doesn't crash and burn (yes, we all expect it to but we have done for the last umpteen years): the long anticipated shift away from a world where the US is the world's dominant reserve currency. 

Having to share the priviledge of borrowing virtually unlimited amounts in USD at low - or at least lower than otherwise - rates is coming at an awkward time for the US.  With total government liabilities of approximately 2-3x GDP (including government-provided pensions and healthcare for the elderly), the US simply cannot afford to borrow at rates higher than nominal growth. Perhaps the shift will happen gradually over many decades and hence have only a minor impact on US bond yields.  For China, this could be more significant.  The dominant Western narrative of China is that excessive investment and debt.  Keeping debt costs low will be critical during what could be a very rocky transition to a more consumption oriented economy. 

Foreign CBs are no doubt attracted by China's rock solid fundamentals. Or, possibly, they are behaving like yield crazed retail investors, keen to pick up a whopping 100 basis points in real yield (0.7% for US 10 yr TIPs vs 1.75% for China (4.75 nominal minus ttm CPI of 3%)).

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