Floyd Norris at the Wall Street Journal thinks China May Be Masking Its Purchase of U.S. Securities

For eight years after the United States resumed running large budget deficits in 2002, China was the largest lender, buying a fifth of the new Treasury securities sold during that span -- an expenditure of more than $900 billion. During 2006, China financed more than half the American deficit. When the financial crisis struck hardest, China spent more than $100 billion on Treasuries over the two-month period of September and October 2008.

But over the last year, China has been a net seller of Treasury securities, according to figures released this week by the American government. If that is true, it would be extraordinary, considering the size of the bilateral trade deficit, and there has been speculation that China has been purchasing Treasuries through accounts in other countries.

The Treasury Department estimated that China reduced its holdings of Treasuries by nearly $11 billion in November alone. For the 12 months through November, as the accompanying charts indicate, China reduced its holdings of Treasuries by more than $36 billion.

For the first 11 months of 2010, American banks, institutions and individuals bought about three-fifths of the $1.5 trillion of additional Treasury debt, while China sold some and other foreign jurisdictions bought the rest.

It is not easy to see how the Chinese government managed to keep its currency from rising more rapidly against the dollar if it did not continue buying Treasuries in 2010, and there has been speculation that it shifted purchases to accounts managed by British money managers.

If so, such purchases would show up as British purchases. As it turns out, Britain is estimated to have been the largest purchaser of Treasuries over the 12-month period, adding $356 billion to its holdings. That made it by far the largest buyer, followed by Japan. The only other major seller during the period was Russia, according to the government estimates.

If China has been buying through money managers, it may be easier at some point for it to begin selling Treasuries through the British channel without others understanding where the selling pressure is coming from.

Who Is Buying US Debt?

Here are two charts from the graphic: Who Buys U.S. Debt?

China

Foreign Buyers and Sellers

See the article for more charts including treasury purchases by US banks and other domestic buyers.

Trade Deficit Math

The two charts above are not believable for a mathematical reason that Norris did not explicitly state: When the US runs a deficit, some other nation must (as a function of pure math) accumulate US assets. Those assets could be dollar reserves, treasuries, investments in US companies, US property, or US equities.

Remember when China tried to buy Unocal, a petroleum producer, for $18.4 billion? The state department nixed the idea as a security concern. The same thing happened when Dubai tried to buy a US port.

Eventually those dollars will come home, they have to, as a function of math. In the meantime, passing the buck like a hot potato does not work.

Pro-Cyclical "Buy Commodities" Math

Some people suggest China should buy oil with those dollar reserves. They never bother to ask the next question: what would Saudi Arabia do with the dollars?

If instead, China bought copper from Australia, what would Australia do with the US dollars?

Another aspect of the "buy commodities" trade is that it would put upward pressure on commodities at a time China is already overheating. Trade math aside, commodity buying would be a pro-cyclical mistake by China leading to bigger booms and bigger busts.

One humorous aspect of all this alleged selloff of US treasuries by China is the hyperinflationist rant "China is Dumping Treasuries" when the reality is that China is likely accumulating US dollars or US treasuries a function of trade deficit math.

My one quibble with Norris' article is his statement "If China has been buying through money managers, it may be easier at some point for it to begin selling Treasuries through the British channel without others understanding where the selling pressure is coming from."

While technically true, please remember the math. Were the US to start running trade surpluses with China, then China certainly would be an outright seller of treasuries or US$ reserves. How likely is that?

"Hot Money" Math

Consider "hot money" accumulating in China. Hedge funds and others are betting in size on an appreciation of the Yaun. That requires China to hold dollar reserves for when the trade unwinds.

When hedge funds do bail on the trade, that would cause China to dip into its dollar reserves and buy Yuan. However, the current state of affairs (inflows betting on Yuan appreciation) is not consistent with falling treasury reserves in China.

For an analysis of the "hot money" trade and bets on Yuan appreciation, please see "Consensus Nonsense"; Is the Yuan Undervalued? Who Wins a Currency War?

Property Math

In regards to toll roads, bridges or US properties, such offers by China would be as noticeable as its failed attempt to buy Unocal.

However, buying shares of IBM, Apple, or other US corporations is certainly possible and could be masked, at least up to the point where position sizes required SEC notification. The risk is in buying overvalued assets in a pro-cyclical setup.

All things considered, one look at an implausible $356 billion in treasuries sitting in the UK likely tells the real story of what is happening: China is masking purchases of US treasuries.