Will the US Treasury bond bubble
burst
laying waste
to China's and Thailand's savings?
By Jon Fernquest 
China
has been accumulating US dollar foreign
exchange reserves
in massive amounts for several years.Today's Financial Times has an important article on the possibility that China could lose a lot of money on these reserves (Read article via Economist's View).
The same risk of loss also exists for Thailand.
Billions and billions of baht are at potential risk. Thailand's reserves even though they are large at $114 billion are still a small fraction of China's reserves at $1,950 billion (See Wikipedia and article and data on Treasury bond purchases).
Bretton Woods II
Bretton Woods II is the name given to the recent pattern of global economic imbalances.The US treasury bond bubble and recent accumulation of US assets as foreign exchange reserves is part of this pattern (Read background).
However, recently there is evidence that the accumulation of US dollar reserves has slowed down or even halted (Read article).
Some believe that China kept its exchange rate undervalued to keep exports cheap and competitive and boost economic growth. In the words of 2008 Nobel Prize in economics winner Paul Krugman:
In the early years of this decade, China began running large trade surpluses and also began attracting substantial inflows of foreign capital. If China had had a floating exchange rate — like, say, Canada — this would have led to a rise in the value of its currency, which, in turn, would have slowed the growth of China’s exports.
But China chose instead to keep the value of the yuan in terms of the dollar more or less fixed. To do this, it had to buy up dollars as they came flooding in. As the years went by, those trade surpluses just kept growing — and so did China’s hoard of foreign assets. ...(Source: NY Times via Economist's View)
Undervalued exchange rates are essential for growth. To quote economist Dani Rodrik:"In
Asia, growth accelerations
are preceded by
a period of sustained
increase in undervaluation, which is maintained during
the period of high-growth" (Source: Dani
Rodrik Blog also read Dani
Rodrik paper on how undervaluation boosts growth ).
And:
"...central
banks may intervene in
currency markets to prevent appreciation, at the cost of
accumulating low-yield
foreign reserves and diverting themselves from their primary goal of price stability"
(Source: Project
Syndicate).
The following factors are believed by some to be behind the undervaluation of China's currency:
1. Capital controls on
capital outflows.
2. Both current account and capital account surpluses in China's balance of payments.
3. Accumulation of foreign exchange reserves in large amounts.
(Source: Congressional testimony)
2. Both current account and capital account surpluses in China's balance of payments.
3. Accumulation of foreign exchange reserves in large amounts.
(Source: Congressional testimony)
Some have also claimed that a risk exists for the US too if China US assets are sold suddenly and funds withdrawn from the US financial system.
Gao Xiqing, president of the China Investment Corporation a sovereign wealth fund managing about $200 billion of China's foreign assets said recently that:
...they
[the US] were hoping that we would be
supportive by not pulling out our money. We know that by
pulling out money, we’re not serving anyone’s good. Including
ourselves. [This is the famous modern “balance of financial terror.” If
Chinese officials started pulling assets out of the U.S. and touched
off a run on the dollar,
their vast remaining dollar holdings would plummet in value.]
So we’re trying to help, at least by not aggravating the problem (Source:
Atlantic
interview).
China's accumulated overseas assets are the savings of poor Chinese people not be squandered according to Chinese public opinion. Gao Xiqing notes:
We
have a PR department, which collects all the comments about us, from
Chinese newspapers and the Web. Every night, I try to pick a time when
I’m in a relatively good mood to read it, because most of the comments
are very critical of us. Recently we increased our holdings in
Blackstone a little bit. Now we’re increasing a little bit our holdings
in Morgan Stanley, so as not to be diluted by the Japanese. People here
hate it. They come out and say, “Why the hell are
you trying to save those people? You
are the representative of the poor people eating porridge,
and you’re saving people eating shark fins!” It’s always that sort of
thing.
To summarize:
1.
There is currently a financial
bubble of US government treasury bonds.
2. This bubble has been fed by the foreign reserve accumulation by Asian states such as China and Thailand.
3. If this bubble bursts Asian states may lose a large amount of money on these reserve holdings.
2. This bubble has been fed by the foreign reserve accumulation by Asian states such as China and Thailand.
3. If this bubble bursts Asian states may lose a large amount of money on these reserve holdings.
foreign exchange reserves
- the currencies of countries held by the central bank of a country for
emergencies and to keep the exchange rate stable (See Wikipedia
and country
list)
Bretton Woods II - the balance of payments patterns that emerged after the 1997 economic crisis
a bubble, a financial bubble, a speculative bubble - when asset prices rise to unreasonably high levels beyond true asset values, investors make a lot of money, and are very enthusiastic about the market, then one day asset prices suddenly drop (the crash), investors lose a lot of money as well as their enthusiasm for the market, besides causing market instability, bubbles also have a negative effect on economies because they temporarily misallocate funds into non-optimal uses" and then quickly pull them out. (See Wikipedia) ภาวะฟองสบู่
the bubble bursts - the end of the bubble when asset prices fall suddenly เมื่อฟองสบู่แตก คือเมื่อมูลค่าสินค้าต่างๆ ตกฮวบ
worst case scenario - one possible future series of events, if everything goes wrong
US Treasury bond bubble - in late 2008 large numbers started to park their funds in safe US government bonds pushing the yield on these bonds down to zero (liquidity trap). Here is a worst case scenario:
laying waste - destroying
accumulation - a large amount of things collected together over a period of time
foreign reserve accumulation - collecting a large amount of foreign currency assets over time
undervalued exchange rate -
accelerations - going faster and faster, at an increasing rate
a hoard - a store of things you have saved and don't want other people to have
growth accelerations - growing faster and faster every year: 2% , 3%, 5% 8% 11% .......
X preceded by Y - X happened before Y
a sustained increase - an increase that continues without going down
maintained - kept at the same level (not allowed to increase or decrease)
intervene in currency markets - when the central bank buys or sells foreign currencies to influence the exchange rate
low-yield - does not have a high return, holders of this security do not make a lot of money
primary goal of price stability - the normal function of the central bank is to control the money supply and supply of credit in the economy to keep inflation under control (See Wikipedia on inflation targeting)
capital controls - restrictions on investment money passing into and out of a country
current account - trade account, exports less imports
capital account - investment money flowing into and out of a country (FDI plus portfolio investment in stocks and bonds, loans, bank account (See Wikipedia on capital account)
a current account surplus - when the value of a country's exports are greater than its imports
a capital account surplus - when there is more investment money flowing into the country than out of the country
balance of payments - measures the payments that flow between a country andother countries, used to summarize all international economic transactions during the year, determined byexports and imports of goods, services, and financial capital, as well as financial transfers (See Wikipedia)
China Investment Corporation - Chinese sovereign wealth fund "responsible for managing part of the People's Republic of China's foreign exchange reserves with $200 billion United States dollars of assets under management, which makes it the fourth largest Sovereign Wealth Fund. This sovereign wealth fund officially began operations on Saturday, September 29, 2007. It bought a US $3 billion stake of Blackstone Group in June and a 9.9% stake of Morgan Stanley worth US$ 5 billion on December 19, 2007." (See Wikipedia)
Bretton Woods II - the balance of payments patterns that emerged after the 1997 economic crisis
a bubble, a financial bubble, a speculative bubble - when asset prices rise to unreasonably high levels beyond true asset values, investors make a lot of money, and are very enthusiastic about the market, then one day asset prices suddenly drop (the crash), investors lose a lot of money as well as their enthusiasm for the market, besides causing market instability, bubbles also have a negative effect on economies because they temporarily misallocate funds into non-optimal uses" and then quickly pull them out. (See Wikipedia) ภาวะฟองสบู่
the bubble bursts - the end of the bubble when asset prices fall suddenly เมื่อฟองสบู่แตก คือเมื่อมูลค่าสินค้าต่างๆ ตกฮวบ
worst case scenario - one possible future series of events, if everything goes wrong
US Treasury bond bubble - in late 2008 large numbers started to park their funds in safe US government bonds pushing the yield on these bonds down to zero (liquidity trap). Here is a worst case scenario:
"Just as the U.S.
government issues mountains of new debt to finance the multi-trillion
annual deficits planned by the Obama Administration, speculative
holders of existing debt will be offering their bonds for sale as well.
In order to prevent a complete collapse in the bond prices the Fed will
be forced to significantly increase its buying.
"However, since the only way the Fed can buy bonds is by printing money, the more bonds they buy the more inflation they will create. As inflation diminishes the investment value of low-yielding Treasuries, such a scenario will kick off a downward spiral. But the more active the Fed becomes in their quest to prop up bond prices, the bigger the incentive to hit the Fed’s bid. The result will be that all Treasuries sold will be purchased by the Fed. But with the resulting frenzy in the Treasury market, and with inflation kicking into high gear, we can expect that demand for other debt classes that the Fed is not backstopping, such as corporate, municipal and agency debt, to fall through the floor, pushing up interest rates across the board.
"In order to “save” the economy from these high rates the Fed will then have to expand its purchases to include all forms of debt. If that happens, run-away inflation will quickly turn into hyper-inflation, and our currency will be worthless and our economy left in ruins." (Source and Warren Buffet comments and his original letter on page 16)
"However, since the only way the Fed can buy bonds is by printing money, the more bonds they buy the more inflation they will create. As inflation diminishes the investment value of low-yielding Treasuries, such a scenario will kick off a downward spiral. But the more active the Fed becomes in their quest to prop up bond prices, the bigger the incentive to hit the Fed’s bid. The result will be that all Treasuries sold will be purchased by the Fed. But with the resulting frenzy in the Treasury market, and with inflation kicking into high gear, we can expect that demand for other debt classes that the Fed is not backstopping, such as corporate, municipal and agency debt, to fall through the floor, pushing up interest rates across the board.
"In order to “save” the economy from these high rates the Fed will then have to expand its purchases to include all forms of debt. If that happens, run-away inflation will quickly turn into hyper-inflation, and our currency will be worthless and our economy left in ruins." (Source and Warren Buffet comments and his original letter on page 16)
laying waste - destroying
accumulation - a large amount of things collected together over a period of time
foreign reserve accumulation - collecting a large amount of foreign currency assets over time
undervalued exchange rate -
accelerations - going faster and faster, at an increasing rate
a hoard - a store of things you have saved and don't want other people to have
growth accelerations - growing faster and faster every year: 2% , 3%, 5% 8% 11% .......
X preceded by Y - X happened before Y
a sustained increase - an increase that continues without going down
maintained - kept at the same level (not allowed to increase or decrease)
intervene in currency markets - when the central bank buys or sells foreign currencies to influence the exchange rate
low-yield - does not have a high return, holders of this security do not make a lot of money
primary goal of price stability - the normal function of the central bank is to control the money supply and supply of credit in the economy to keep inflation under control (See Wikipedia on inflation targeting)
capital controls - restrictions on investment money passing into and out of a country
current account - trade account, exports less imports
capital account - investment money flowing into and out of a country (FDI plus portfolio investment in stocks and bonds, loans, bank account (See Wikipedia on capital account)
a current account surplus - when the value of a country's exports are greater than its imports
a capital account surplus - when there is more investment money flowing into the country than out of the country
balance of payments - measures the payments that flow between a country andother countries, used to summarize all international economic transactions during the year, determined byexports and imports of goods, services, and financial capital, as well as financial transfers (See Wikipedia)
China Investment Corporation - Chinese sovereign wealth fund "responsible for managing part of the People's Republic of China's foreign exchange reserves with $200 billion United States dollars of assets under management, which makes it the fourth largest Sovereign Wealth Fund. This sovereign wealth fund officially began operations on Saturday, September 29, 2007. It bought a US $3 billion stake of Blackstone Group in June and a 9.9% stake of Morgan Stanley worth US$ 5 billion on December 19, 2007." (See Wikipedia)
Sovereign Wealth Fund
(SWF) -
a state-owned investment fund composed of financial assets
such as stocks, bonds, property, precious metals or other financial
instruments. Sovereign wealth funds usually invest globally
but here local
investment in the Thai economy is indicated (See Wikipedia)
be supportive - try to help
a run on the dollar - when everyone is trying to sell their dollars, trying to put their money in another currency quickly, when everyonme does this there is a panic and the value of the dollar would fall sharply
plummet in value - when the value decreases suddenly by a very large amount
aggravating the problem - making the problem worse
squandered - wasted
public opinion - what the people who live in a country are thinking about current events (See Wikipedia)
be supportive - try to help
a run on the dollar - when everyone is trying to sell their dollars, trying to put their money in another currency quickly, when everyonme does this there is a panic and the value of the dollar would fall sharply
plummet in value - when the value decreases suddenly by a very large amount
aggravating the problem - making the problem worse
squandered - wasted
public opinion - what the people who live in a country are thinking about current events (See Wikipedia)
Here is the op-ed piece with vocabulary:
Asia is the victim if the bond bubble bursts
By Yu QiaoMarch 31 2009
President Barack Obama is set to urge leaders to boost government spending to save the world economy. European Union countries are expected to focus on fixing lax financial regulatory systems. For Asian countries, however, the key agenda issue is the safety of their assets denominated in dollars, as they look ahead to a devalued dollar from rising US sovereign debt.
Most of Mr Obama’s stimulus spending is devoted to social programmes rather than growth promotion, which may America’s exacerbateover-consumption problem and delay sustainable recovery. On top of this, the unprecedented fiscal stimulus, with the Federal Reserve’s move to inject money into credit markets, contains self-destructive seeds. The US risks ending the dollar’s role as the reserve currency, especially considering there is already $10,000bn (€7,535bn, £7,009bn) in US Treasury debt, and much more in liabilities from the costs of social security, healthcare and financial institution bail-outs.
The provision of stable, reliable and viable dollars may be subordinated to short-term US interests, posing a risk to global monetary stability. In the long term, America may seek to resolve its economic mess by devaluing the dollar at best and a default at worst. This is depicted in a Chinese proverb: “Drinking poisonous liquid to quench thirst”. History points to examples such as the collapse of the Bretton Woods system in the early 1970s. It is the foreign holders of US obligations denominated in dollars that would end up paying.
provision of Y - giving
Y to people
X subordinated to Y - X made less important than Y
interests - connections that you may benefit from, therefore affects your attitude to it and the way you deal with it
posing a risk - creates danger, the possibility of harm or damage
global monetary stability - global exchange rates do not go up and down a lot (low volatility)
resolve - solve a problem
a proverb - a short sentence or two, well-known and often repeated, which expresses a truth based on common sense or practical experience, for example on the best way to behave (See Wikipedia)
Bretton Woods system - the system of fixed exchange rates and monetary management by the IMF established after World War II, set up rules for commercial and financial relations among the world's major industrial states right (See Wikipedia)
obligations - debt, liabilities, money that must be paid in the future to another person
X subordinated to Y - X made less important than Y
interests - connections that you may benefit from, therefore affects your attitude to it and the way you deal with it
posing a risk - creates danger, the possibility of harm or damage
global monetary stability - global exchange rates do not go up and down a lot (low volatility)
resolve - solve a problem
a proverb - a short sentence or two, well-known and often repeated, which expresses a truth based on common sense or practical experience, for example on the best way to behave (See Wikipedia)
Bretton Woods system - the system of fixed exchange rates and monetary management by the IMF established after World War II, set up rules for commercial and financial relations among the world's major industrial states right (See Wikipedia)
obligations - debt, liabilities, money that must be paid in the future to another person
Analysts have warned of the dangers of the US Treasury bond bubble that developed in late 2008. Although insurance against sovereign debt default may reduce credit risk, it is unable to safeguard the real value of dollar-denominated securities. If this bubble burst, east Asians would be victims. Their economies directly hold more than $1,600bn of US sovereign debt, or 25 per cent of the total held by the public. Including direct holdings, Asians may hold half of the outstanding public-owned Treasury bonds. China, by some estimates, directly and indirectly holds more than $1,200bn of US Treasury bonds. If the dollar collapsed, the consequences would devastate Asians’ hard-earned wealth and terminate economic globalisation.
No other international monetary system offers a viable alternative. However, we can make the main reserve currency power more accountable by creating an instrument to help manage the global crisis.
viable - can
succeed, can continue to exist and live
offers a viable alternative - provides a system that works
a power - a powerful country
a reserve currency - one of the currencies with foreign exchange reserves holdings
the main reserve currency power -
accountable - having to explain what you did to others, cannot just act independently the way you want all the time
make the main reserve power more accountable - make the US also do what other countries want (incorporate them into decision-making)
an instrument - an investment (stocks, bonds, options) bought and sold in a system or exchange
offers a viable alternative - provides a system that works
a power - a powerful country
a reserve currency - one of the currencies with foreign exchange reserves holdings
the main reserve currency power -
accountable - having to explain what you did to others, cannot just act independently the way you want all the time
make the main reserve power more accountable - make the US also do what other countries want (incorporate them into decision-making)
an instrument - an investment (stocks, bonds, options) bought and sold in a system or exchange
The basic idea is to turn Asian savings, China’s in particular, into real business investments rather than let them be used to support US over-con[sumption] are vulnerable to any fall in the value of the dollar, equity claims on sound corporations and infrastructure projects are at less risk from a currency default. But Asians do not want to bear the risk of this investment because of market turbulence and a lack of knowledge of cultural, legal and regulatory issues in US businesses. However if a guarantee scheme were created, Asian savers could be willing to invest directly in capital-hungry US industries.
First, Asian countries could negotiate with the US government to create a crisis relief facility. The CRF would be used alongside US federal efforts to stabilise the banking system and to invest in capital-intensive infrastructure projects such as a high-speed railway from Boston to Washington DC.
Second, Asians could pool a proportion of their holdings of Treasury bonds under the CRF umbrella to convert sovereign debt into equity investment. Any CRF funds, earmarked for industrial commitment, would still be owned and managed by their respective countries. In return, Asians would hold minor equity shares that would, like preferred stock, be convertible .
pool - when many
people put their money or resources together to use for some purpose
under the Y umbrella - included with Y, part of larger group Y
convert sovereign debt into equity investments
earmarked for Y - set aside or reserved for special purpose Y
commitment - a promise to do something
minor - not the most important or largest
equity shares - stock shares, owning part of a company
preferred stock - stock shares in a company that receive dividends but no voting rights at share holder meetings, must be paid before holders of ordinary stock (common stock)
convertible [preferred stock] - preferred shares that can be exchanged for for ordinary shares (common stock)
under the Y umbrella - included with Y, part of larger group Y
convert sovereign debt into equity investments
earmarked for Y - set aside or reserved for special purpose Y
commitment - a promise to do something
minor - not the most important or largest
equity shares - stock shares, owning part of a company
preferred stock - stock shares in a company that receive dividends but no voting rights at share holder meetings, must be paid before holders of ordinary stock (common stock)
convertible [preferred stock] - preferred shares that can be exchanged for for ordinary shares (common stock)
Third, the US government would act as the guarantor, providing a sovereign guarantee scheme to assure the investment principal of the CRF against possible default of targeted companies or projects. Fourth, the Fed would set up a special account with the US government to supply liquidity that the CRF requires to swap sovereign debt into industrial investment in the US.
The CRF would lessen Asians’ concern about implicit default of sovereign debts caused by a collapsing dollar. It would cost little and help the US by channelling funds to business investment. Conventional Keynesian policies – fiscal and monetary expansion on a national basis – cannot solve the problem but will make it worse.
implicit - expressed
in an indirect way, not direct meaning
default, default on debt - fail to pay back a loan on time
sovereign debts - money that a country owes other countries or banks
implicit default of sovereign debts caused by a collapsing dollar - if foreigners own a lot of a country's foreign debt they lose if the dollar depreciates
channelling funds to Y - giving funds to Y
conventional - commonly used, standard way of doing something
Keynesian policies - encouraging or dampening growth by increasing or decreasing government spending or by lowering or raising taxes, respectively
default, default on debt - fail to pay back a loan on time
sovereign debts - money that a country owes other countries or banks
implicit default of sovereign debts caused by a collapsing dollar - if foreigners own a lot of a country's foreign debt they lose if the dollar depreciates
channelling funds to Y - giving funds to Y
conventional - commonly used, standard way of doing something
Keynesian policies - encouraging or dampening growth by increasing or decreasing government spending or by lowering or raising taxes, respectively
The writer is a professor of economics in the School of Public Policy and Management, Tsinghua University, Beijing
(Source: Financial Times, Asia is the victim if the bond bubble bursts, 31-03-09, Yu Qiao, via Economist's View, link)
