Long-term US governt interest rates and Chinese currency intervention

Discussion in 'Economics' started by ptirookie, Mar 13, 2012.

  1. ptirookie


    I'm wondering about a sentence - article from The Independent (UK) - that I don't manage to make sense of, it's the following:

    "...Long-term US government interest rates - Treasury yields - also dropped, helped not only by the Fed's monetary stance but also by an insatiable demand from the Chinese and other emerging investors as they intervened to prevent their currencies from appreciating excessively."

    My question is: How the simple fact to buy a US government bond (albeit in large quantities for the Chinese investors) could be thought as a currency intervention to prevent its value appreciation ?

    My guess is, it may not be easy to explain that mechanism. But I would be glad to hear your thoughts about it.

    Thank you.
  2. Banjo


    Morganist, where art thou,please explain this apparent conumdrum to your countryman.
  3. The interest rate is changed by alterations in liquidity in money supply or increases or decreases in the availability of credit.

    By changing the interest rate the availability of credit changes making the money supply a greater or lesser amount which in turn changes its exchange rate through the supply of monetary units. In other words a lower interest rate means more money that can be leant out, this in turn means there are more dollars for other countries to buy making it cheaper against their currency.

    So the interest rate is directly linked to exchange rates through this mechanism.

    I don't think the comment in the Telergraph is correct. Or at least not correctly described.

    I think they are saying that the emerging countries are buying foreign debt to reduce the credit supply in their own country this would stop their currencies from being too strong because the supply of money has not increased domestically because credit has not been expanded in their own country. Also currency has to be exchanged to buy US Treasuries this would reduce the value of the currency of the country that purchased the bonds.

    Has that helped?
  4. ptirookie


    Thanks Morgan (& Banjo)

    These explanations make sense from a strictly mechanical point of view, which is itself useful.

    By way of contrast, to take the example of China (with opaque, obscure accounting and no real credibility in terms of economic reporting), they can use these "double steps": pegging their currency along with buying US Treasuries to reduce their money supply by replacing it with USD dollars and limit the value increase of their currency. But, in their case, as a Communist Dictatorship, why even bother to buy US Treasuries ? They could just as well keep manipulating their currency to maintain it at a low level ? Does that have anything to do with their huge trading relationship with the US and the Rest of the World ?

    I don't mean to engage in a complicated discussion about the subject, which I may myself explore.
  5. The Chinese are dependent on American demand. It is called Chimerica.
  6. China accumulates a large amount of dollars (as well as other ccies), due to its trade surplus with the US (and other countries). It needs to invest these surpluses and the UST mkt is where they do it (for a variety of reasons).
  7. ptirookie


    Bonjour Martin,

    Thanks for detailing the process.

    If my understanding is correct, American Companies and People are buying huge quantities of goods from China, paying Chinese in USD. And the Chinese Dictatorship is giving back (lending back) this huge quantities of USD by being a creditor to the US Government - effectively buying US Treasuries. And the US Government, debtor at this point, is paying interests to the Chinese on the money its own people and companies spent in the first place to consume goods. It seems funny enough, isn't it ?

    My question would be: what is the strategy of China for acting like this ? What's the upside for them ? (keeping low their currency, keep control of their domestic inflation?) At first glance, it seems China is adopting a risky behavior.

    Thank you.
  8. Not sure if "funny" is the word that I would use, but yes, that's roughly what's going on. To be sure, China buys a lot of US mtge paper as well, not just treasuries.

    Well, there's a lot of ways to understand what's in it for China and there's a LOT of research and discussion on the subject. However, let me leave you with this chart, which I have posted before and which might answer your question:

  9. ptirookie


    Hola Martin ! Que tàl ?

    You dropped in there the Purchasing Power Parity concept. I've came across this piece of research from an Asset Manager. Some facts emerging:

    - "...during the last two decades, US lost 6 million jobs in the manufacturing sector..." (going overseas) - represents about 4% of a 10% US unemployment rate

    - "...during the last decade, China accumulated 1.4 trillion $ of US Govnt Debt and 2.3 trillion $ of assets..."

    - "...if the exchange rate RMB/USD remains at an artificially low rate, China could accumulate up to 3.8 trillion $ of US Govnt Debt and 7 trillion $ of assets..."

    - "...reinforcing the trade surplus for China, and the trade deficit for US..."

    - "...an analyst from the Economic Policy Institute (US), estimates that between 2001-2008, because of this trade deficit with China - partially caused by an undervalued renminbi - 2.4 million jobs have been lost to the benefit of Chinese workers..." - represents about 1.6 % of a 10% US unemployment rate

    - "...anyway, the real exchange rate of the renminbi will find equilibrium whether through a change in its nominal value or through the relative rates of inflation of China and US"

    I will not pursue on the part about the political solutions ("protectionism", "quantitative easing"...). But it seems "funny" may not have been the right word to comment on this situation.

    Coming back to the Purchasing Power Parity,

    "... - From this concept - the RMB could be undervalued as much as 60% compared to the US dollar..."

    My question regarding your chart would be, what are your main conclusions from it or the situation. What figures or facts do you find relevant to analyze this peculiar situation ?

  10. I didn't really drop the PPP concept here, tbh... It's just a handy way to harmonize historical data, nothing more.

    As to my conclusions, I dunno... I suppose I am suggesting that there's a certain historical inevitability in what we're witnessing. You could view current developments as the world "reverting to a very long-term mean". China could be implementing its policies with the goal of achieving its "rightful" place in the world. In that case, economics gives way to other, socio-political considerations. The price, unfortunately, is pretty high, but the Chinese seem willing to pay it.
    #10     Mar 23, 2012