Alan Greenspan’s Call of Checkmate on China is Premature

June 18, 2007 – In her recent speech to the Democratic National Committee Clinton told the story of one of her New York constituents that approached her and complained about the loss of manufacturing jobs with the question: “Why can’t we get tough on China?” Hilary replied,“How do you get tough on your banker?” It’s not only China, but the U.S. economy now depends on the Middle East as well to keep its economy going. The situation has reversed almost 180 degrees from the past where developing countries’ economies could tank overnight based upon the decisions of the U.S. Federal Reserve (and they did — remember what happened to Argentina in the 1970’s?) Now, other countries hold the fate of the U.S. economy in their hands.

However, according to former Federal Reserve Chairman Alan Greenspan, there is little reason to fear a wholesale pullout by China out of U.S. government bonds, because he claimed that China would not be able to find anyone that would want to buy the bonds. Greenspan no doubt made these comments because China has been stating their wishes to offload U.S. dollars for three years now with no real action taken. At the Davos World Economic Forum in January of 2004, Zhu Min, general manager and advisor to the President of the Bank of China, stated: “All the Asian countries hold dollars for security reasons, but at some point, this has to end… There is a love affair. But everybody knows that this love affair has to end. The United States is benefiting from China using its trade surplus to buy U.S. Treasury paper as a reserve currency, along with other Asian nations. But in the long run, this is not sustainable…. China will focus more and more on domestic demand, which is growing fast. Then we won’t be able to finance the U.S. deficit. We cannot keep exporting our goods at a growth rate of 30%.” Of course, Zhu Min wasn’t an official government spokesperson, but as the President of the Bank of China, he was merely stating the concerns of his fellow bankers at the time.

It appears now that Greenspan spoke to soon and that Zhu Min is finally going to get his wish. It turns out that Greenspan could be right about China’s inability to find anyone that would want to buy their U.S. government bonds, but wrong about China’s inability to find a solution to this problem. China may have found a solution to getting rid of its U.S. government bonds by acting both as the buyer and seller. Last week, China’s Ministry of Finance announced that it would sell a special treasury bond to raise money to buy foreign-exchange reserves from the central bank, a finance ministry official said.

“Since it will be a special treasury bond issue, the state council will decide on the amount and then submit to the National People’s Congress for approval,” Zhan Jingtao, director-general of the treasury department of the ministry, said Monday.

China’s currency reserves have reached US$1.2 trillion (HK$9.36 trillion) as exports boomed. The government is setting up a state investment company that will use some of the reserves to buy investments with higher yields. The State Investment Company agency probably will be set up before the end of this year. Zhan declined to confirm media reports that the finance ministry will sell bonds to buy US$200 billion to US$300 billion of foreign reserves to put into the State Investment Company. “Detailed amount of the bond sales and how it will be sold is still under discussion,” he said, adding that the decision is likely to be made before year- end. Does this State Investment Company sound familiar?

It should, because it is exactly the same type of entity as the state-formed agencies that Middle Eastern countries have formed to invest the bulk of their petrodollars. Yet the media provides zero coverage of the actions of these Middle Eastern state-sponsored investment companies even though they at times manage many multiples of the amount of reserves controlled by their respective central banks. And my guess is that China wants to accomplish exactly the same. This strategy will move U.S. bonds from their central bank into a state investment authority and outside the scrutiny of the press and media, which only seems to care what happens in reserves held inside central banks. Once domiciled in their state investment authority, China would have much more liberty to find creative solutions to offload the U.S. bonds.

Looks like Greenspan’s call of checkmate on the Central Bank of China may have been a little bit early.

[tags]politics and stocks, Alan Greenspan, China, dollar crisis[/tags]

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