The massive amount of US debt financed by the Chinese has frequently been characterised as “vendor financing” considering how much we buy from them.
In a piece discussing the latest flow of funds data from the US, Brad Setser discusses what seems to have changed politically in China, that suddenly its holdings of US debt are so controversial.
Part of it, I suspect, is a fairly systematic tendency to underestimate the risks associated with large current account deficits that stem from excesses in the private sector. The fiscal deficit — and China’s current Treasury purchases — are a lot more visible than the complex chain of risk taking that allowed Chinese financing to help sustain the excess of the United States’ housing boom. But part of it is that the over the past year or so China has been providing the US with more financing and in some sense getting less in return. For a long-time, the rise in Chinese official financing of the US coincided with a rise in US purchases of Chinese goods.
Vendor financing yields obvious benefits, helping to offset its hidden costs. However, over the past year Chinese purchases of US financial assets have far exceeded US purchases of Chinese goods. That may have something to do with the shift in China’s tone. To many in China, the risks associated with financing the US seem to have gone up even as the benefits that China gets in return have gone down.
Now the liquidity, depth and security of our markets still makes US debt a compelling place for China to recycle all its cash. But that crucial vendor financing component is going away. This means two things. One is that China isn’t getting the exports it would like to see, and two is that the need to recycle their own currency so that the yuan stays cheap against the dollar becomes less and less important.
Indeed, at the moment, it would seem unlikely that any of the export-heavy BRICs could possibly stop buying dollars, since they all want to keep their exports cheap. But as the consumer fades from the national stage — and the continued deleveraging of households suggests that they won’t be back in full force anytime soon — means this currency issues goes to the back burner. And thus one reason to buy dollar debt starts to disappear, leaving only our breadth and promise not to default as our main selling points.
That’ll probably be good enough for a while, but it’s not that compelling. And to the extent that these countries would like to keep buying more from overseas, to accelerate an increasingly consumer-led economy, then the weakness of their currency simply becomes counterproductive.
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