Photo: Yuri Obukhov via Flickr
Remember when the Treasury Department modified its rules for government bond auctions two years ago? Turns out “technical modernization” was a euphemism for China buying more treasuries than it had disclosed, according to a new report from Reuters.The Chinese government buys most of its U.S. treasuries through China’s State Administration of Foreign Exchange (SAFE), a unit of the Chinese central bank, and China is said to hold about $1.115 trillion or approximately 26% of U.S. government debt.
According to the report, the Treasury found that China was buying more U.S. debt than it had disclosed and was possibly violating auction rules which limit one bidder to 35% of a batch. At the time, acting assistant Treasury secretary told his staff not to talk about any one creditor so the matter could be handled quietly without upsetting Beijing. Another official categorically instructed officials not to refer to China or SAFE in email subjects. Reuters reports:
The Treasury’s acting assistant secretary for financial markets, Karthik Ramanathan, told subordinates in an email: “Please let’s stick to the ‘Modernization of Auction Rules’ when outside requests come in on the (rule) change. Please DO NOT emphasise the guaranteed bid portion, or mention any specific investors.”
Typically the Treasury holds weekly auctions and investors can buy up bonds directly or via 20 primary dealers. China had used multiple firms to buy U.S. Treasuries through purchases dubbed “guaranteed bidding” and to U.S. officials it would appear as though the firms were adding them to their own portfolio. Reuters reports:
China was forging gentleman’s agreements with primary dealers to purchase a certain amount of Treasury securities on offer at an auction without being reported as bidders in that auction, according to the people interviewed. After setting the amount of Treasuries the guaranteed bidder wanted to buy, the dealer would then buy that amount in the auction, technically on its own behalf.
Because firms aren’t prevented from later selling them on a secondary market this isn’t illegal, breaching the 35% limit and acquiring a control stake however is. On June 1, 2009 officials changed the Uniform Offering Circular to prevent guaranteed bidding. Immediately, the auctions saw a jump in bids through primary dealers (in the absence of guaranteed dealers) skyrocketed after the ruling. Meanwhile Deutsche Bank, Goldman Sachs, JPMorgan, RBS Securities and UBS were all approached for secret bid arrangements.
U.S. officials have been wary of the massive political clout such moves give the Asian giant. Moreover, if China suddenly decided to dump its treasuries it would push interest rates higher crushing U.S. markets. In a bid to mollify investors, officials have since raised the amount of securities it was possible to buy at a single auction from $750 million, to $2 billion.