China and all the U.S. debt they hold

Ambrose Evans-Pritchard at the Telegraph looks at one of the more interesting developments today in an increasingly shaky global monetary system in this report about how the Chinese government may be exiting U.S. corporate and municipal bond markets.

China orders retreat from risky assets
China has ordered managers of its vast currency reserves to withdraw from risky dollar assets and retreat to core debt guaranteed by the US government, a clear sign that Beijing is battening down the hatches for fresh trouble on global markets.

A Communist Party directive leaked to the Chinese-language edition of the Asia Times said dollar reserves should be limited to US Treasuries or agency mortgage debt such as Freddie Mac that enjoys Washington's implicit backing.

BNP Paribas said the move has major implications for global risk assets. "The message from Beijing is that we don't like this environment," said Hans Redeker, the bank's currency chief.

"When the world's biggest investor turns risk-averse, that is something you take notice of. We think this could become the new theme for the markets in the medium-term," he said.

Recall that a couple years ago the Chinese quickly soured on agency debt from Fannie Mae and Freddie Mac back around the time that the two became wards of the state.

Unless they've taken a renewed interest in GSE-related debt (which, according to this report, it looks like they have), they'd be restricted to U.S. Treasuries only.

The directive covers both the State Administration of Foreign Exchange (SAFE) and China's state-controlled commercial banks. Together they have an estimated $3 trillion (£1.9 trillion) of foreign holdings.

The exact break-down of China's holdings are a state secret but it is understood that SAFE bought large amounts of corporate debt as well as municipal and state bonds during the boom years of 2006 and 2007. Any move to liquidate holding of California debt at this crucial juncture could have serious implications.
The exact motives for China's shift of strategy are unclear. Analysts say the authorities may fear that the end of quantitative easing by the US Federal Reserve could cause risk spreads to widen sharply, triggering heavy losses. The shift in policy appears unrelated to the US spat with China over Taiwan.

In related news, Reuters reports that the PLA (Peoples Liberation Army) is urging that the sale of U.S. debt be considered in response to continued U.S. arms sales to Taiwan.

This was bound to come up eventually - after all, if you were a Chinese military leader, you'd probably look at all tools that were available to you in response to a military threat. To think that they would not is naive and now U.S. debt held by foreigners starts to take on some of the same characteristics of MAD (Mutually Assured Destruction) from the late 1900s.