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What is China Saying? Sustainability and Indirect Bidding

Posted by Larry Doyle on July 29, 2009 9:47 AM |

Reading through the financial tea leaves this morning, I am struck by two developments yesterday. In the midst of the U.S.-Chinese economic summit in Washington, little surprise that Chinese diplomats voiced concern about the U.S. fiscal deficit. The Wall Street Journal highlighted this topic in reporting Chinese Convey Concern on Growing U.S. Debt:

A show of unity from the U.S. and China at the end of a high-profile two-day conference was overshadowed by continuing Chinese concerns about the U.S.’s growing pile of debt.

The U.S.-China Strategic and Economic Dialogue, a forum designed to foster closer cooperation, closed on a similar note to that set at the start by President Barack Obama, who stressed the countries'”mutual interests.”

The two powers vowed to maintain efforts to pull the global economy out of recession and shore up financial markets. They also agreed on a plan to create more-balanced global growth in the future.

But like a banker visiting an overextended borrower, Chinese economic leaders repeatedly conveyed to their U.S. hosts the importance of managing the U.S. debt. Chinese Vice Premier Wang Qishan, in talks with Treasury Secretary Timothy Geithner and other officials, urged the U.S. to protect the value of the dollar.

“As a major reserve currency-issuing country in the world, the U.S. should balance and properly handle the impact of the dollar’s supply,” Mr. Wang said through an interpreter Tuesday.

China’s Finance Minister Xie Xuren said the delegation “expressed the view that credible steps should be taken to prevent fiscal risks and to ensure sustainability” and that “high attention should be given to fiscal deficits.” He said Mr. Geithner “stated clearly” that the U.S. is placing “a lot of importance” on the deficit.

What exactly do the Chinese mean by sustainability? Clearly, they are emphasizing the need for America to lessen its deficit, which will likely surpass $2 trillion this year alone.

While Chinese officials made these strong statements regarding our deficit, the U.S. Treasury auctioned $42 billion in 2 yr notes. How were these notes received? Not very well. In fact, the indirect bidders only purchased 33% versus close to 69% a month ago.

Who are these indirect bidders? Recall that on June 1, with no fanfare or warning, Treasury redefined ‘indirect bidders’ in our Treasury auctions. I highlighted this topic in “Turbo-Tim Takes ‘Indirect’ to a Whole New Level”:

Geithner just redefined ‘indirect’ buying in our U.S. Treasury auction process without a hint that this major piece of information was even up for review. Let’s look deeper into this sleight of hand. The Wall Street Journal sheds a little bit of light on this development in Is Foreign Demand as Solid as It Looks?

The sudden increase in demand by foreign buyers for Treasurys, hailed as proof that the world’s central banks are still willing to help absorb the avalanche of supply, mightn’t be all that it seems.

When the government sells bonds, traders typically look at a group of buyers called indirect bidders, which includes foreign central banks, to divine overseas demand for U.S. debt. That demand has been rising recently, giving comfort to investors that foreign buyers will continue to finance the U.S.’s budget deficit.

But in a little-noticed switch on June 1, the Treasury changed the way it accounts for indirect bids, putting more buyers under that umbrella and boosting the portion of recent Treasury sales that the market perceived were being bought by foreigners.

In light of this newly redefined measure of indirect bidding, 33% is an extremely low level. Did the Chinese take a shot across our bow and pass on yesterday’s 2yr auction? Things that make you go, “hmmmm . . .”


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