After five straight months of net selling, China buys up Treasuries

NEW YORK / BEIJING - China, the largest foreign holder of United States Treasuries, bought more federal bonds in April for the first time since October despite concerns over the US debt level.

China's purchases of US debt rose $7.6 billion to $1,153 billion - the first month-on-month increase since its holdings reached $1,175.3 billion in October, according to the Treasury International Capital report, known as TIC. China boosted its holdings after selling most of its bonds for five straight months.

Overall, foreign nations were net buyers of US long-term securities, with purchases rising by $30.6 billion in April.

Japan remained the second-largest foreign buyer of US debt, holding $906.9 billion at the end of April, down $1.0 billion from March.

The US hit its $14.3 trillion debt limit on May 16. With the debate on raising the debt limit heating up between the White House and Congress in Washington and an Aug 2 deadline to decide on the limit looming, foreign investors of US Treasuries have been watching closely for any new development.

Federal Reserve Chairman Ben Bernanke warned Tuesday that the debt ceiling shouldn't be used as a bargaining chip to force "necessary and difficult fiscal policy adjustments".

"We should avoid unnecessary actions or threats that risk shaking the confidence of investors in the ability and willingness of the US government to pay its bills," Bernanke said.

Global rating agency Moody's recently warned that it would consider putting the US' credit rating on review if the White House and Congress don't reach an agreement on raising the debt limit by mid-July. Moody's has warned that it may downgrade the US' top-notch credit rating.

Steven Hess, senior credit officer at Moody's Investors Service, told China Daily that these kinds of reviews do not happen often.

"We just want to have the market on notice that the rating will go down if an interest payment is missed," Hess said.

But he said bond holders would not experience any significant loss in their holdings.

"Even if an interest payment is missed, it will be made up within just a few days. It will not go on for long because it is more or less due to a particular political circumstance," Hess said.

What the review does, Hess said, is to warn the US government into swiftly dealing with deficit and budget problems in an adequate way.

Even if a downgrade in rating is avoided, an agreement that doesn't have a "significant and credible deficit reduction plan over the long-term" will lead to a "negative outlook" on the Aaa rating (indicating the rating could go down in the next year or so), Hess added.

Outspoken Chinese economists have warned that China should stop buying US Treasuries, over worries that the US government securities will be more risky due to the nation's deficits.

The strongest remarks came from Li Daokui, an adviser to the central bank in China, who urged US politicians to assure China that its massive investments in Treasuries are safe, Reuters reported last week.

Li said there is a risk that a US debt default may occur. John Taylor, a professor of economics at Stanford University in California, doesn't believe there is a default scenario.

"There is no default scenario for the US - we always pay our debts," Taylor said. "China should be thinking about other problems such as inflation, exchange rate and the overheating of the economy; decisions about foreign assets are largely dependent on their decisions on the exchange rate, that is the issue."

Taylor said the reason China buys US Treasuries is to prevent the exchange rate from appreciating so much.

David Backus, a professor from Stern School of Business at New York University, said it is natural for buyers to be concerned but he sees no reason to stop buying it.

"Over the last few years, US debt has looked a lot better than the European debt," Backus said.

Fan Jishe, a professor of American studies with the Chinese Academy of Social Sciences, thinks China should take a cautious approach in increasing its holdings of US bonds because a decision not to raise the debt ceiling would intensify China's concerns.

"The recent decision of the Congress could result in a tremendous cash back-flow to the US because the country needs more greenback to stimulate its economy and employment," Fan said. "But on the other hand, this is not bad news for China because the cash back-flow to the US will ease China's inflationary pressure."

Wayne Morrison and Marc Labonte, analysts from the Congressional Research Service, said that the reduction in Chinese Treasury holdings would cause the overall foreign demand for US assets to fall, which would cause the dollar to depreciate.

"If the value of the dollar depreciated, the trade deficit would decline as the price of US exports fell abroad and the price of imports rises in the US," according to a report written by Morrison and Labonte.

China Daily