August 24,2009

China's Opaque US Treasury Portfolio Serves for a Lousy Financial Times Analysis

By Xu Yisheng

China's "Undeclared War"?


Such reads the headline of a story in the UK's Financial Times, covering the announcement by the U.S. Treasury Department in June of China's reduction of its holdings of US Treasury bonds, maintaining that China is implementing dollar exit strategy.


That's a bit much, and the analysis stems from incorrect or incomplete facts.


Rigorous researchers, among them Brad Setser, a researcher for the U.S. Council on Foreign Relations, and Stephen Green, chief economist at Standard Chartered Bank China, have pointed out that China buys US Treasury bonds not only through its own accounts but also through accounts in Britain. It is difficult to have a complete measure of the size and move in China's holdings in US Treasury bonds only according to data on Chinese territories released by the US Treasury Department.

According to US Treasury data, in June China substantially reduced its Treasury bond holdings by $25.12 billion, the largest reduction in a single month since 2000. But in the same month Britain sharply increased its holdings of Treasury bonds by $77.2 billion, its holdings ranking third after China's and Japan's.


China has bought lots of Treasuries through London-based brokers and those are recorded in the British account in accordance with the distribution by territoriality. Stephen Green says, "I suspect that China continues increasing its holdings of U.S. Treasury bonds."


In April, China reduced its holdings of Treasuries by $4.4 billion, to heated discussion. In the same month, UK increased its holdings of by $24.6 billion. Brad Setser points out that in April China's two or three-year US government bonds worth $22.4 billion were purchased by UK investment institutions.


In April and June, the China territories data showed the reduced holdings of US Treasuries, while in the same two months China's foreign exchange reserves significantly increased by $55.1 billion and $42.1 billion, respectively.


The data released in June of the sharp reduction of China's large holdings of US government bonds has triggered widespread discussion. Many Chinese opinion leaders, concerned about the safety of China's dollar-denominated assets, have publicly noted the action with pleasure, while a number of voices have questioned such a substantial reduction.


But whether the data involved are complete in the heated discussion is unclear.


London is a world financial center and the core of the Eurodollar market. It is a common practice to invest in US financial markets through London. Brad Setser says China's central bank has bought US Treasury bonds through UK institutions before, and several oil-exporting countries often purchase Treasury bonds through institutions in the UK.


Stephen Green points out that the Treasury's monthly data is organized on a territorial basis, but the annual statistics classify most positions bought by UK in the previous year go to China's account. From the annual data revision over the recent five years, the upward adjustment of Treasury bonds held by China is basically the same as the UK's downward adjustment.


Apart from London, other financial centers such as Singapore and New York may also be used as channels for China to invest in U.S. assets market.


Besides its central foreign exchange business center with four investment divisions in Beijing, China's State Administration of Foreign Exchange operates the SAFE Investment Company, Ltd., in Hong Kong, as well as trading rooms for direct investment in London, Singapore, and New York.


If the careful observations of Brad Setser and Stephen Greens are correct, it is hard to conclude that China sharply reduced its US Treasuries holdings in June.


On the issue of the investment in US Treasuries by foreign exchange reserves, both China's academic community and its market rely on data released by the US, including from first-line well-known scholars who have served on the Fed's monetary policy committee. But studies based on incomplete data end up unconvincing.


It is a great pity. Stephen Green says it is possible that China's foreign exchange reserve managers are unwilling to reveal their moves to the markets, for China's investment in US bonds has been heavily criticized. Therefore, it seems good to route big orders through London.

Who is in the dark? The U.S. Treasury knows who has bought their bonds for it adjusts the ownership of the holders instead of the size of territories on an annual basis. It is those in the domestic market who are confused. This situation is misleading. Your correspondent hopes foreign exchange reserve management departments will deal more transparently with information.

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