Rate alart? - China may sell U.S. bonds

Discussion in 'Wall St. News' started by isaac000, Mar 12, 2007.

  1. http://www.chicagotribune.com/business/chi-0703100152mar10,0,4916055.story?coll=chi-business-hed

    China may sell U.S. bonds
    Move to diversify could raise rates

    By William Sluis
    Tribune staff reporter
    Published March 10, 2007

    In a move that speaks to China's growing significance in the global economy, its government said Friday it will look for more aggressive ways to invest sizable portions of its massive $1 trillion currency reserves.

    The new Chinese pool of money, expected to total $200 billion to $300 billion, would instantly create one of the world's most powerful investment funds, analysts said.

    With much of China's $1 trillion in reserves currently invested in ultrasafe U.S. Treasury debt, a significant shift out of the American bond market could have an impact on American consumers. Interest rates would rise, making it more expensive to borrow money for a home mortgage or car loan or to pay credit card debt.

    Chinese officials said they planned to form a government investment firm to manage some of its holdings, an indication that China has tired of earning small and predictable returns and wants to look elsewhere.

    "It's entirely possible that they are ready to diversify their investment portfolio," said economist John Silvia of Wachovia Corp., who predicts that any changes would not come quickly.

    The Chinese have been threatening for several years to look in new places for safeguarding their ample reserves.

    For Americans, "this will be a challenge, no doubt about it," Silvia said. "It likely will mean higher mortgage rates and a weaker dollar. But these effects could take 5 or 10 years to be fully felt."

    Huge holdings of Treasury bonds by both China and Japan have been taken for granted by Americans for the last decade. Their involvement in debt markets has helped to hold down long-term interest rates, especially for mortgages.

    While some analysts viewed the Chinese announcement with alarm, Chicago economist William Hummer said Americans should welcome the move.

    "Our government has been demanding for months that the Chinese take steps to boost their currency, which is too cheap and is creating inflation," said Hummer, of Wayne Hummer Investments.

    He said diversification of Chinese assets around the globe will do little harm here. If the dollar weakens a bit against the Chinese yuan, so much the better, Hummer said. It might slow the torrent of goods coming into this country, making American factories more competitive.

    "Moving this huge reserve of currency elsewhere around the globe will be good for world financial markets, without doing any meaningful harm in this country," he said.

    China's currency reserves are the world's largest, and they continue to grow rapidly because the country has an enormous trade surplus. If the reserves continue to expand at a rapid rate the money placed in the new investment fund might be replaced without a need to sell American holdings.

    Describing the new agency as the State Foreign Exchange Investment Co., China said it will place hundreds of billions of dollars in "strategic assets," namely mines, oil fields and entire companies around the globe.

    The government of Singapore has a similar investment vehicle, known as Temasek Holdings, which manages about $84 billion in assets, and which Chinese officials cited as a model.

    "Unlike other governments that hold their reserves in gold or the currencies of other countries, this announcement indicates the Chinese may decide to buy stocks in companies or commodities," said Chicago investment manager Marshall Front.

    Wherever they place their money, he said, they will act slowly. "The Chinese will move at a measured pace because they certainly wouldn't want to disrupt their big investments in this country," said Front, of Front Barnett Associates. "Any rapid or concerted selling could diminish the value of those holdings."

    One reason the Chinese must move slowly is that "the United States is their top market. Stability is their No. 1 goal," said Todd Lee, head of the Greater China Group at Global Insight in Lexington, Mass.

    Over the past 21 months the Chinese have allowed their currency to decline by about 7 percent against the dollar, partly to satisfy U.S. demands, he said.

    "They have begun to move a bit faster in strengthening the yuan, but they don't want to create any ripples," Lee said.

    Less than two weeks ago a steep sell-off in Chinese stocks triggered a global sell-off in equities, including a brief 540-point drop in the Dow Jones industrial average. Global markets still are recovering from that setback.

    In 2005 a Chinese firm tried to acquire a major U.S. oil company, Unocal Corp., but was unsuccessful. At the time members of Congress expressed concerns that the loss of such a strategic resource could be dangerous.



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