Tags: Monan | China | Treasurys | debt

Expert: The End of Cheap Financing Is Near

By    |   Friday, 13 September 2013 08:42 AM

The "era of cheap financing" for the United States may be drawing to a close.

China's dumping of U.S. Treasurys will cause a "large and permanent increase in America's borrowing costs," according to Zhang Monan, a researcher at the China Macroeconomic Research Platform and a fellow at China's State Information Center.

Foreign investors sold a record $54.5 billion in long-term U.S. debt in April. China alone slashed its holdings by $5.4 billion, Monan writes in an article for Project Syndicate.

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Foreign investors hold approximately 30 percent of U.S. government debt. Emerging countries, often using large trade surpluses to support their economic growth, have gorged on U.S. Treasurys, she points out.

"Over the last decade, these countries' foreign-exchange reserves have swelled from $750 billion to $6.3 trillion — more than 50 percent of the global total — providing a major source of financing that has effectively suppressed long-term U.S. borrowing costs."

But depreciation of the U.S. dollar and increasing volume of U.S. debt is undermining the purchasing power of bond investors, diminishing their foreign-exchange reserves and threatening their financial security.

"Nowhere is this more problematic than in China, which, despite the recent sell-off, remains by far America's largest foreign creditor, accounting for more than 22 percent of America's foreign-held debt."

China's huge purchases of Treasurys have fueled its trade surplus, but its reserves have suffered, Monan says, noting that its 10-year Treasurys yield only 2 percent when they should yield 3 to 5 percent.

In short, China must begin off loading its U.S. securities as risks of its massive holdings outweigh the benefits.

Worries that spiking interest rates could sink bond values helped motivate foreign investors to dump Treasurys, and that sell-off will probably continue as the Federal Reserve exits its quantitative easing long-term asset purchases.

Rising rates will destabilize the bond market, although they are unlikely to spark a 1994-style bond market collapse, Monan predicts.

"Given that China will reduce the overall size of its reserves as its population ages and its economic-growth model shifts toward domestic consumption, a substantial sell-off of U.S. debt is inevitable — and, with it, a large and permanent increase in America's financing costs."

"Holding too much U.S. debt is not wise at a time when Treasury yields rise and prices fall," agrees a senior economist at the Chinese Academy of Social Sciences, a government think-tank, according to Reuters.

"On the other hand, the adjustment has been marginal considering China's massive holdings of U.S. debt, and China cannot dump U.S. debt, which could spook markets and upset the U.S. government," he tells Reuters.

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The "era of cheap financing" for the United States may be drawing to a close.
Friday, 13 September 2013 08:42 AM
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