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Keys to the Treasury

(China Daily)
Updated: 2008-12-17 07:56

China's increased purchase of US Treasury securities should not be interpreted as an endorsement of the assumption that the US can borrow its way out of the current financial crisis.

Related readings:  China increases US treasury holdings  US treasury bonds 'still the best option'

Any negligence over the severity of the issue will cause big trouble for both the debtor and the creditor, especially when the world economy is facing its worst slump in decades.

After replacing Japan as the top foreign holder of US Treasury debt in September, US data shows that China further expanded its lead by buying $65.9 billion worth of US securities in October.

With an overall holding of US Treasury securities standing at $652.9 billion, China now has ostensibly deemed such lending as an acceptable way to deploy its $1.9 trillion foreign exchange reserves.

However, the country's seemingly expanded appetite for US Treasury bonds at the moment does not indicate that the latter will be a good investment in the long run or the US government will stick to its dependence on foreign capital.

China's swelling trade surplus created not by accelerated exports, but by rapidly declining imports, and its slowing but still huge inflow of foreign direct investment have added tens of billions US dollars to its foreign exchange reserves for the past several months.

With few options to invest its increasing reserves safely and profitably, China may thus have to buy more US Treasury securities in spite of growing domestic skepticism that such purchases may incur huge losses later.

Besides the undesirable consequences that reducing purchases of US Treasury bills will have on global markets, it is also a bad idea to sell them before the world economy can restore stability.

If creditors stop recycling the dollars they accumulated back into US, interest rates in the US would rise to undermine that government's efforts to bailout distressed financial institutions and companies.

In a time of crisis, expanded government spending financed by foreign capital may be necessary to prevent the worst from happening.

Yet, as more and more creditor countries introduce their own stimulus packages to boost domestic demand, the US government should not expect continuous inflow of more cheap foreign capital to fund its one-after-another massive bailouts.

The current strong foreign appetite should not be taken by the US government as solid proof of the long-term value of its Treasury bonds.

Instead, it should race against time to undertake painful but critical reforms to revive its economy before such demand peaks any time soon.