There was an international festival at  one of the universities here some time ago – foreigners were invited to showcase different elements of their particular cultures. Kitschy stuff: the Africans had stalls selling bread/meat, the French had… a cheese sampler. Was this close to setting up a stand to sell “American: complex financial instruments. Invest today.” Didn’t go through with it in the end – assessment was that event-goers wouldn’t be very interested in purchasing Tony futures fund, thereby financing my current consumption of junk through debt.

MSM seems to have caught on to a similar meme – the NYT has a simplistic article “China Losing Taste for Debt From the U.S.” Sure, Chinese purchases of U.S. debt will be down in 2009, but only because trade is falling off a cliff, and Beijing is caught scrambling to get its pants on before the pitchforks come out. It’s a complex topic - Yves Smith offers an excellent dissection:

Smith: One remarkable omission in the piece is the failure to mention that the massive FX reserves resulted from China running first a hard, and then a dirty peg against the dollar. And correspondingly, there is no consideration of why China no longer needs to be as active to keep the yuan (which now appears to be back to a hard peg) where China wants it to be. A presumably smaller current account surplus and a capital exodus would seem to be prime suspects…

Ah yes. The currency peg rears its ugly head.

NYT: The strength of the dollar against the euro in the fourth quarter of last year contributed to slower growth in China’s foreign reserves, said Fan Gang, an academic adviser to China’s central bank, at a conference in Beijing on Tuesday…

Smith: No mention, zero, zip, nada, that the reason that China had to sop up so many Treasuries was to keep the RMB from appreciating too much versus the dollar, and that the strength of the dollar relieved China of the need to intervene…

Exactly. There hasn’t been much coverage (here or elsewhere) of how badly China is going to take it in the face from the financial crisis – perhaps I’m biased since I now spend the majority of my time talking to unemployed migrants – but the point still stands: at present, China has no domestic growth engine, and a bubble in real-estate (construction is much more labor intensive than export industries). The only realistic avenue open to 5-year support harmonious society plan will be to massage the already declining export machine. Additionally, there are concerns that given the existing amount of FX reserves, the People’s Bank cannot allow too much Yuan appreciation, which would rapidly erode the value of existing FX holdings, already under pressure from inflation:

Smith: Very few seem to be looking at the gives and gets in a hard-nosed fashion. China has to know the Treasuries it holds will, under NO plausible scenario, be in economic terms worth face value. In fact, were there any realistic way for them to dump them now, that would probably be the value-maximizing course of action…

… That does not mean China will dump Treasuries, but merely that any cold-blooded analysis needs to start from how bad likely scenarios would be for the Chinese, what actions are open to them, and how they affect risks and outcomes.

The critical question seems to be the extent to which China can maintain a peg to prevent appreciation without altering the size of their reserves, and what happens if the Dollar weakens. Given the amount of treasury debt that will be issued ($1.3 trillion - seriously?) any decline in purchases might feel like Beijing abandoning America’s debt binge – unfortunately the Times article fails to acknowledge any of this. As Smith points out, there doesn’t seem to be many good analyses of these scenarios – I certainly don’t have the background required.

With regards to another emerging trend – animosity – Smith also (accurately) points to the potential for anti-American sentiment in China, even as anti-Chinese rhetoric in the U.S. seems to be becoming more chic:

Separate and apart from China’s changing fortunes, the continued purchase of US debt was becoming controversial in bureaucratic and popular circles. The tone increasingly was that China had been snookered into buying lousy US paper. And since the regime had depended on continued growth to maintain legitimacy and social cohesion, the officialdom will need to find scapegoats for the downturn. Regardless of where one thinks the truth really lies, it’s a no-brainer that the US will become a leading culprit. 

Brad Setser also has a rebuttal, pointing out that Chinese purchases of short-term U.S. treasuries actually increased in September-October.