Sure A Not

In the home stretch of a rocky 2023, China and Warren Buffett are warning the global economy that the year ahead could be even more precarious.

Not directly or in tandem, of course. But the financial decisions being made in Omaha, Nebraska and Beijing don’t seem very promising for the 12-14 months ahead.

Buffett’s Berkshire Hathaway conglomerate, for example, is raising its cash position in headline-generating ways. Its cash pile is now a record-breaking US$157.2 billion amid rising global interest rates and a lack of solid investment options.

Xi Jinping’s China is also going as liquid as it can — and rapidly — without panicking investors everywhere. As of the end of August, China’s stockpile of US Treasury securities dropped to the lowest level in at least 14 years.

What’s more, Beijing’s exposure to US government debt has fallen about 40% in just the last decade. Xi’s Communist Party has long since passed the dubious honor of Washington’s top banker to Japan. But at No 2, with $805.4 billion of US Treasuries, China’s selling activity is raising eyebrows in government offices and trading pits around the globe.

Though some might claim foul geopolitical play, there could be perfectly rational economic reasons for Xi’s government to offload US debt. As economist Torsten Slok at Apollo Global Management sees it, “growth in China is slowing for cyclical and structural reasons, and Chinese exports to the US are lower. As a result, China has fewer dollars to recycle into Treasuries.”

Brad Setser, a former US Treasury Department economist, says the suspicion that Xi is exacting revenge on the US “sort of makes sense. China does worry about the weaponization of the dollar and the reach of US financial sanctions. And why would a rising power like China want to fund the Treasury of a country that China views as standing in the way of the realization of the China dream ­– at least in the Pacific?”

Yet, Setser says, “that is not what I believe is actually happening.” The bulk of China’s post-2012 efforts to diversify its reserves “have come not from shifting reserves out of the dollar, but rather by using what could have been reserves to support the Belt and Road and the outward expansion of Chinese firms.

Those non-reserve foreign assets, strangely enough, seem to be mostly in dollars; almost all the documented Belt and Road project loans, for example, have been in dollars.”

Whatever the motivation, though, the global financial system is right to worry about the wider fallout from China selling dollars, including surging US yields. US bond rates recently hit a 17-year high and further spikes are sure to hit asset markets around the globe.

Slok notes that rising US yields are “inconsistent” with the view that stock markets are undervalued. “In short, something has to give,” Slok notes. “Either stocks have to go down to be consistent with the current level of interest rates. Or long-term interest rates have to go down to be consistent with the current level of stock prices.”

Strategist Lauren Sanfilippo at Bank of America sees China’s selling of Treasuries, circa 2023, as a bookmark of sorts. The other was in 2013, when senior People’s Bank of China officials declared it was “no longer in China’s favor to accumulate foreign exchange reserves.” That, she argues, marks “the beginning of a downtrend in China’s holdings of US Treasuries.”

In late 2013, Sanfilippo says, China owned more than $1.3 trillion in Treasuries, in excess of 23% of all foreign holdings. More recently, and over the last 18 months, China has sold more than $200 billion in Treasuries.

This isn’t the full picture, though. All in all, Sanfilippo says, “the landscape of buyers of US Treasuries has shifted. While foreigners own 30%, that share has been declining. The Federal Reserve owns 18%, or another $4.7 trillion, down from a peak of $6 trillion via the monthly run off of $60 billion of Treasuries through their ongoing quantitative tightening program. Importantly, and increasingly coming to the table, are hedge funds, pensions, retail investors, mutual funds and insurers as marginal buyers.”

In Sanfilippo’s view, the “bottom line” is that “foreigners are still a major source of demand for our paper. An important fact, particularly when accounting for a growing US deficit. A list of concerns such as a shifting geopolitical landscape, polarizing US politics, hits to the US credit rating, or a worrying pile of debt, could all chip away at the allure for US assets over the long term.”

But, she notes, “good reasons remain for our preference of US dollar-denominated assets relative to non-US dollar assets. The US economy remains the largest, wealthiest and most competitive economy backstopped by the US corporate sector. Globally speaking, that’s a rare combination that continues to drive flows into US assets, both foreign and domestic.”

Even so, Washington’s bankers in Asia losing faith en masse could be the game-changer officials in Beijing have long feared. The nine Asia-Pacific economies holding the most US debt are sitting on more than $3 trillion of it.

That, at a moment when the US national debt tops $33 trillion and the Fed might soon extend its most aggressive tightening cycle since the late 1990s. Add in extreme political dysfunction in Washington putting the last of its AAA credit ratings at risk.

The risk is that all that red ink prompts more of Washington’s bankers to buy fewer Treasuries or, worse, call some loans.

In March 2018, Cui Tiankai, China’s then-ambassador to the US, hinted that Beijing might scale back on debt holdings amid concerns about losses. “We are looking at all options,” he said.

That same year, Fan Gang, a top PBOC adviser, said the time to diversify had come. “We are a low-income country, but we are a high-wealth country,” Fan said. “We should make better use of capital. Rather than investing in US government debt, it’s better to invest in some real assets.”

Those concerns in 2018 were being expressed seven years after the US lost the first of its AAA ratings – from S&P Global Ratings. They also came nearly a decade after then-Chinese premier Wen Jiabao in 2009 urged Washinton to safeguard its creditworthiness.

“We have made a huge amount of loans to the United States,” Wen said at the time. “Of course, we are concerned about the safety of our assets. To be honest, I am a little bit worried.” Washington, Wen stressed, must “honor its words, stay a credible nation and ensure the safety of Chinese assets.”

One big worry for China and the rest of Asia: that bickering in Washington between President Joe Biden’s Democrats and the Republicans loyal to predecessor Donald Trump might brawl in ways that prompt Moody’s Investors Service to downgrade the US as Fitch Ratings did in August.

With approval ratings in the low 40s, at best, Biden’s path to defeating Trump in November 2024 is narrowing. Trump has suggested in the past that he might default on US debt to retaliate against China.

Also on Trump’s watch, from 2017 to 2021, America’s standing in Transparency International’s annual corruption perceptions index nosedived 11 places since from 2017 to 2021 – to a 27^nd ranking from 16^th place.

These aren’t comforting data points for China and other Asian governments effectively holding Washington’s mortgage. As 2024 approaches, Xi, the strongest Chinese leader since Mao Zedong, may also be trying to avoid terrible headlines about hundreds of billions of state wealth lost to US yield volatility. It’s complicated, of course.

The resulting surge in US yields if China accelerated Treasuries selling would boomerang back on China’s economy, just as it’s growing the slowest in three decades. As rates rise, American consumers will buy fewer Chinese goods. The US, of course, is already slowing. In October, the US added just 150,000 nonfarm payroll jobs, a marked slowdown.

“Some of [October’s] weakness will reverse next month with the United Auto Worker (UAW) strike ending, but there is more weakness beyond that,” says economist Thomas Simons at Jefferies, a US investment bank. “This data fits in line with the trend that had been in place before the surprisingly strong September print.”

Yet as Buffett’s Berkshire noted in a recent report: “The effects of significant increases in home mortgage interest rates in the US over the past year has slowed demand for our home building businesses and our other building products businesses. We continue to anticipate certain of our businesses will experience weakening demand and declines in revenues and earnings into 2024.”

As such, economist Mark Williams at Capital Economics doubts that Beijing is letting political objectives dictate foreign exchange reserve management.

“Falls in the value of China’s recorded holdings of US Treasuries tell us little about whether China is divesting from the dollar,” Williams notes. “A broader look at the data suggests that it isn’t, despite geopolitical pressure to decouple. The analysis of the US Fed suggests that China has been a net buyer overall,” of dollar assets.

Setser, who’s now with the Council on Foreign Relations, thinks worries about China dumping US debt are overdone. In his view, there “aren’t realistic channels for financial contagion” from the second-biggest economy to the US. Bottom line, he sees “no real scenario” in which China “disrupts” American markets in ways the Fed can’t handle.

But can the PBOC handle things? Some of the US Treasuries sales of late seem to reflect a desire to have funds available to keep the yuan from extending its 5.5% drop this year.

On the one hand, it’s increasing the odds China will import inflation amid elevated global commodities prices. On the other, it raises the risks of additional defaults among property developers as offshore debt payments become more expensive.

Still, as recent actions by Xi’s government and Buffett suggest, there may be an even bigger economic storm brewing in 2024. As such, some battening down of the hatches may be in order.

Follow William Pesek on X at @WilliamPesek

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