China’s Compensation for Taking Dollar Risk…

I am at a conference and haven’t had time to delve into the results of the stress tests — or to really delve into Friday’s news flow. Normal blogging likely will resume on Monday.

In the interim though, I thought it would be interesting to do some quick calculations to see how much interest income China has been receiving on its US bond portfolio. The US BEA provides a fairly detailed breakdown of the United States’ income balance with China. As one would expect, the US is paying far more interest now than it did in 2000 — or for that matter 2004.


The US data likely underestimates payments made to China in 2008 — largely because interest payments are calculated — I suspect — based on the information in the survey data (if the US knows the coupon on the bond and the holder, it can estimate payments) and the 2008 data hasn’t revised to reflect the last survey. Moreover, the US data — even after the survey revisions — likely understates China’s holdings on US corporate bonds.

Nonetheless, it is possible to compare the interest the US is paying to China to a very rough estimate of China’s US holdings — and thus to calculate the implied interest rate China is receiving on its investment in the US. The average interest rate the US is paying has clearly turned down:


The estimate of China’s US assets I used for the calculation is very very rough — I assumed 70% of China’s total (non FDI) foreign assets are in dollars, and compared the rolling four quarter sum of interest payments to China’s estimated average holdings of dollars over the past four quarters. If I had taken the time to convert my monthly data on China’s estimated US holdings into a quarterly data series, I could have produced a better estimate — one that no doubt would show that China is receiving a slightly higher average interest rate on its US holdings. (the calculation above slightly overstates China’s holdings of US bonds, and thus understates the average interest rate on those bonds)

Directionally, though, there is no doubt that the average cash return on China’s bond portfolio is falling, as one would expect. And it no doubt has further to fall, especially now that it has shortened the maturity of its Treasury portfolio by buying so many Treasury bills.

While the market value of China’s long-term bonds soared during the crisis — that doesn’t provide much comfort to an institution that doesn’t mark to market. Conversely, China’s cash compensation for taking dollar risk is falling.

That though was a risk China’s government opted to take when it opted to maintain an undervalued exchange rate and thus to accumulate dollar assets. There was always a risk that the renminbi value of China’s dollar bonds would fall. And by say 2003 it wasn’t exactly a secret that the Fed tends to respond to a US slowdown — and a fall in US inflation — by cutting US policy rates.

Originally published at the Council on Foreign Relations blog and reproduced here with the author’s permission.

0 Responses to "China’s Compensation for Taking Dollar Risk…"

  1. Mandarin   May 11, 2009 at 11:21 pm

    I doubt that the aggregate amount of interest looms large in the imagination of Chinese planners – they only showed evidence of searching for higher rates of return just before the crisis hit, plunging into the US markets via newly created sovereign wealth funds.No, it is the aggregate of reserves and their underlying value which appears more important. These represent many things to the planners. First, they are a source of liquidity undergirding the Chinese financial system. Second, they are the means by which China can invest directly and indirectly throughout the world given that the Renminbi is still not a convertible currency and there is only a tentative RMB trading zone. Third, they enable the purchase of military and hi tech hardware and contribute to the regime’s power projection. Finally, they fit a psychological and cultural pattern which favors saving – accumulating a hoard is a sign of wisdom and more importantly, an insurance policy against future risk.For all these reasons, the Chinese leadership – so conservative in normal times – will respond aggressively to American policies which threaten to depreciate the value of such reserves. I would be less concerned about RMB devaluation and a “beggar they neighbor” policy, which would prove fruitless given the magnitude of their export contraction. Rather, the pressure will be applied to America, rhetorically as we have already seen; by accelerating the diversification of their reserves; by curtailing purchases of US debt and lastly by concerted action with Russia to form an alternative currency and trading bloc.Indeed this isn’t a prediction, it’s an extant and ongoing situation. China is not going to tolerate a continuation of the global financial and trading scheme if the principal amount of their dollar reserves is depreciated by unrestrained money creation by the American authorities.

  2. Macstibs   May 15, 2009 at 6:54 am

    1. A more rigorous look at the data might include an examination of export data as well. Theoretically, exports were inflated by keeping the currency artificially cheap. The Chinese essentially engineered a massive wealth transfer from American consumers to Chinese exporters, but it was just that … engineered.2. No one really talks about Geithner’s 180 on China. He went from being an outspoken currency hawk to a patsy in a couple of months. I wonder what drove that behavior. Everyone talks about the Fed “destroying” the dollar by devaluing it, but isn’t the dollar artificially over-priced? Isn’t the Fed essentially “speaking softly and carrying a big stick” ?

  3. Anonymous   May 20, 2009 at 10:11 am

    Hi Brad, I tried to log onto your CFR blog page and I got an authentication error. The server expects a username and password to be able to see your blog posts at the CFR web site. This hasn’t happened before, and I wanted to know if there’s a change in public access to your CFR blog posts. I’m hoping either that this is a temporary error on the CFR web site, or that you will now continue to make your posts at the RGE web site or at some other location accessible in public. It would be nice if you could clarify.