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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 . . .”


  • Aaron Kramer

    Bad news LD, very bad news, but no one in the MSM is covering the story. Maybe we should start informing people that the US is the largest recipient of Direct Foreign Investment in the world. If that disappears than we will be looking at much higher interest rates, a collapse in the dollar and a shrinking economy. If Obama raises taxes to cover some of the debt (they can’t cover it all) than consumers have less disposable income leading to a a shrinking economy and higher unemployment and a falling dollar. I don’t think this administration will make any tough choices and will try to charm its way to success. The next 18 months will be very interesting to say the least.

  • Ryan


    It was my understanding that China bought U.S. bonds primarily as a result of our trade deficit with them which is accumulating at a lower rate in 2009 than in 2008 or prior years (but which according to the U.S. Census is about $86 billion so far in 2009). While I understand their concern about our fiscal deficits (any lender should be concerned about the fiscal discipline of its borrower—a lesson we know too well from the subprime mortage debacle), one of the driving forces behind the accumulation of the national debt in recent years (our fiscal discipline or lackthereof not withstanding) has been the trade deficit with China. They had no problem buying our bonds when it was furthering the growth of their export prowess. All of that said, my question is…If it is true that they are changing their buying behavior with respect to the treasury auctions, will that not pose a problem for their own exports given that they are now the #1 export economy (having recently passed the U.S.) and that the U.S. is the largest consumer of those exports? I know they are trying to transition away from being as export dependendent as they have been, but that does not happen overnight. Secondly, if they are suddenly unwilling to buy treasuries, will that not raise the yield that the U.S. is required to offer on the treasuries it is selling (with fewer buyers in the market), subsequently raising its borrowing costs and hurting its creditworthiness with respect to the the approximately $772 billion in treasuries that China already owns as of May 2009?

    The next question that follows from this for me is what implications these events might have for the debate about whether going forward we will continue to be in a deflationary environment or transition to an inflationary environment and when that transition might occur and the implications for asset allocation should we believe that it will occur.

    On a separate note I found the part about Treasury changing the definition of indirect to be quite interesting.

    • Larry Doyle


      Lots of fabulous insights on your part. Allow me to address:

      1. I have been informed that the Chinese to a large extent have shifted a large percentage of their dollar denominated holdings into very short maturities (T-bills and short Treasury notes) so that they would be less exposed to a move higher in rates.

      2. No doubt that as we go through a transition in our own economy, China also needs to go through a transition in their economy as well. However, China is, relatively speaking, in the VERY early stages of adapting to a market based economy so the transition, while significant, should not be as challenging. Be mindful as well that China has 4 times the population of the U.S. with an economy only 1/5th the size. They definitely have room to grow over there.

      In my opinion, we run the risk of longer term inflation simply because Bernanke and Geithner are determined to keep the money spigot open for as BB said, ‘an extended period.”

      All fascinating developments which will continue to play out and which Sense on Cents will be monitoring closely.

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