What if China Sells All of Our Bonds?

I get these occasionally, “we owe money to China” or “what if China sells off all of our bonds”.

I think the first part is much more complicated than simply “we owe money to China” and can explained walking through why China owes Treasuries:

1. We buy goods from China ABC Co.
2. Before we buy we need to covert dollars to Yuan (CNY), so we sell USD and buy Yuan for the transaction
3. Ultimately the above transaction arrives on the currency market and puts downward pressure on USD
4. We are net importers of Chinese goods; as a result there should be more supply of USD relative to CNY, lowering the value of USD/CNY. 
5. Except there is no downward pressure because China’s Central Bank intervenes and buys those dollars
6. So now what does their Central Bank do now?  They obviously want USD or wouldn’t have purchased it, so they invest in the safest USD asset around – Treasuries.  

That is probably an oversimplification, but what I am getting at is that we “owe” China money due to trade.  Would they sell our bonds?  I don’t know, maybe.  So what?

1. If they are selling, someone is buying.  Given where interest rates are there is plenty of demand. 
2. This would put downward pressure on USD, making our exports more competitive.
3. Given their large holdings of Treasuries, why would China have a “fire sale”?  It would crush exports to their largest (or second largest) customer and harm their own central bank balance sheet.
• Note #1 assumes this is done more orderly than just dumping all $1.5t or so Treasuries on the market.

Again, this is an oversimplification and I am certainly missing a few steps.  Further, I will admit this is above my pay grade.  I am just trying to outline that it is much more complicated than “we owe China” and if they do sell our bonds it could yield positive benefits to our exports.

Chinese Real Estate Bubble?

“Falling home values. Debt-strapped borrowers. Real estate woes dogging the economy.”  Sounds like the US circa 2007, but it is also going on in China right now. 

The LA Times recently wrote an article about China’s property market, highlighting many of the issues it faces.  While it seems certain prices will fall, will it be orderly?  Or will it be more chaotic like the US?  Here are some points on both:

Orderly:

• China’s government has intentionally slowed development
• Lending and purchasing restrictions could be lifted if need be
• Leverage is not nearly as bad as it was in the US ( first-time buyers have a 30% down payment required)
• Hundreds of millions of Chinese are moving into cities
• The drop is not surprising as I can recall this forecast by China bulls and bears alike for some time
• Equity prices in China are down pretty far over the last 12 months (greater than 20% on the Shanghai Composite Index­) indicating some of the pain may be priced in

Chaotic:

• Home prices have fallen for 3 straight months
• Average home prices are down about 40% from their 2009 peak
• Beijing has nearly 2 years worth of inventory
• Sales are plummeting
• Property sector is one-fifth of GDP and a huge employer
• Local governments are highly dependent on sales/appreciation
• Banks have issued a record number of home mortgages
• Home buyers have staged numerous demonstrations (see the personal side in the linked article)
• China has built empty cities

The answer to this question will have broad ramifications for China and the rest of the world, which is hoping that China becomes more of a consumer and/or feeds its demand for commodities. 

I myself can’t say I know how it will ultimately shake out.  On the one hand there are things that certainly don’t pass the smell test (see the Ordos video), on the other hand there seem to be some tangible differences between our housing market and theirs.