Sunday, 7 November 2010
Barron's sees China buying hard assets, not Treasuries
The most emailed article of Barron's was about China: China's sure bet (http://online.barrons.com/article/SB50001424052970203281504575590290564950892.html?mod=BOL_article_full_popview#articleTabs_panel_article%3D1).
The aricle shows the changing prefeences of China for hard assets instead of Tresuries. That shift is going on for years, but seems to be accelerating. For years and years economistst think that the investment preferences of the excess currency reserves of Emerging Markets goes more and more in the direction of the most riskless investment, US Treasuries. Indeed, that seemed to be the case, but Houston, we have a problem: China is believing more and more in hard assets (equity participations and commodities). That is especially disastrous for the US. In our book we have showed a chart that the US for decades had a current account deficit and still had a net income stream from abroad to the US. On the investments abroad (of multinationals) a high income was received. The foreigners invested almost everything in treasuries with their paltry rate of return. The net result was that the higher amount of investments of abroad in the US generated less return than the US got from his multi nationals etc. So it was no problem at all for the US to have a big current account deficit for decades. As long as the foreigners were too afraid to buy anaything else tha Treasuries the Us had a field day. Because of the too big demand the yields on Treasuries went down too much so everybody became more scared and bought even more Treasuries at the benefit of the US with lots of windfall profits.
So now China is no longer believing that you should no longer take any risk and invest everything in treasuries. The forced buying of China of US assets because of the big curent account surpluses (that is by definition true: a current account surplus with the US leads to a forced buying of US assets that China can't get rid of, only the price can fluctuate of those assets) is going less and less to treasuries. The Chines prefer to buy hard assets. That is not only very clever because it has a higher return but is also seen ore and more as less risky since the Us is indulging in more and more QE2.
China cannot escape to increase its US assets as long as they have a current account surplus. But how you invest that surplus that is what China can influence. When that preference changes from Treasuries to more risky investments (maybe they are less risky when QE2 goes too far) then that could have big consequences: better prices for risky assets and lower prices for Treasuries (=higher bond yields).
China is an example for many countries. Many people say China is very cleverly expanding its influence with clever investments. They want to copy the policies of China even more than the investment policy of Warren Buffett. That means more countries will invest their current account surpluses more in hard assets and less in treasuries. Japan seems to be a loyal buyer of Treasuries, but also wants to take more risk (buying Japanese equities). By the way Japan can pauze for years with buying of Treasuries, so you can't build on japanese buying of Treasuries.
So all in all you can see lots of clouds in the sky for Treasuries when the Fed stops buying Treasuries at any price.