Does China know something about the US economy that Gulf authorities don't? China made headlines this week when the US Treasury's latest data revealed that it appeared to be selling its holdings of US government debt - so much so that in December it lost its place as the number one lender to Washington, allowing Japan to take the top spot.
The news sparked a flurry of speculation that Beijing, which has been grumbling about the weakness of the dollar and engaging in a tit-for-tat round of trade sanctions with the US, might finally be making good on threats to diversify its US$2.4 trillion (Dh8.81tn) in foreign-exchange reserves out of the dollar. But a closer look at China's holdings of US securities reveals that it may instead be betting on a US economic recovery. While China has been selling shorter-term US treasury bills that investors use as a safe haven in times of economic turmoil, it has been buying longer-term US treasury bonds and at the same time accumulating US stocks, raising its overall holdings of long-term American securities.
"China is also buying more US equities through CIC [the China Investment Corporation], its sovereign wealth fund," says Rachel Ziemba, an economist at RGE Monitor in New York who tracks foreign purchases of US securities. The Gulf, on the other hand, appears to be betting against the US. Gulf oil exporters have been reducing their exposure to the US, the Treasury data show, selling US government debt along with China, but also selling other US securities, including stocks.
The answer as to why China and the Gulf are diverging in US markets may lie not so much in their views on the US economy, but on their divergent economic trajectories. Thanks to extensive government spending, China has managed to keep its economic growth on target near 8 per cent, and is now trying to restrain lending to cool what many economists warn is a newly forming asset price bubble. Gulf economies, on the other hand, are still grappling with slower growth and, particularly in the UAE's case, trying to raise cash to pay off debts racked up before the crisis that are now coming due. A recovery in oil prices ensures that revenues will continue to swell, but only as fast as they can pump out their barrels of crude.
Central banks in the Gulf and China buy US treasury bonds for much the same reasons. Most international trade is conducted in US dollars, so big net exporters generate lots of dollars, and as companies earning them bring them home they exchange them into local currency to pay their bills. Normally, more dollars coming in than going out would push up the value of the local currency until the trade surplus abated.
To prevent that from happening and reducing their country's export competitiveness, central banks buy up the dollars and hold them as reserves. That unleashes more local currency into the economy, which is inflationary, so central banks then end up having to soak up the extra cash by borrowing it from local banks. This practice of accumulating reserves became much more pronounced after the Asian financial crisis, when currency speculators hastened a balance of payments crisis in Thailand, and then in Indonesia and South Korea by demanding dollars for local currency and so running through the central banks' pile of dollars. With lots of short-term dollar debt owed on long-term local projects, the governments had no choice but to submit to painful rescues by the IMF.
With their vast piles of greenbacks, central banks have little choice but to invest them in dollar-denominated assets. And investors have long considered US government bonds the safest variety of those. Thanks to the US government's appetite for borrowing big, the US treasury bond market is one of the few places where an investor on the scale of a central bank can count on being able to buy or sell billions of dollars worth of bonds without having to scrounge around for someone to take the other side of the trade and so move the market.
"It just remains a fact of life that the US dollar remains the reserve currency and the treasury market is the most liquid market of its sort," says Giyas Gokkent, the chief economist at National Bank of Abu Dhabi. "So it's a natural choice for central banks to park their liquidity there." Bonds are no different than any other commodity, though, in that they are governed by the laws of supply and demand. The more bonds there are, the less they are worth. A bondholder's two biggest enemies, therefore, are oversupply and inflation, which reduces real return on a bond.
With the US government borrowing more and more - its debt is projected to rise to $18.3tn in the next four years - big lenders such as China are becoming increasingly vocal about their unhappiness with the growing supply of US debt. The dollar's recent declines, moreover, are inflationary. China is unhappy about that, too. China sold $34bn worth of US government bonds in December, while Gulf oil exporters sold $900 million in bonds. Their sales coincided with a broader sell-off of a net $30bn in US government debt by foreign investors.
But analysts say looking at a one-month snapshot can be misleading. Data for individual countries can fail to capture the entire picture, they say: many purchases by Gulf central banks, for example, are not accurately reflected in the Treasury Department's data because they outsource much of their trades through banks in the UK. Increasingly, analysts say, China is doing the same. Such caveats aside, some argue that the recent sales are merely a retreat from the massive buying earlier this year as central banks sought a safe haven for their money during the crisis.
China's big sales, for example, still left it with $755.4bn in US government debt, down from a peak of $801.5bn as recently as May. Likewise, Gulf oil exporters were still holding $186.8bn in December, down from a May peak of $192.9bn. And that foreign liquidation of Uncle Sam's debt was only a slight reduction from a peak of $2.4tn set in November. Foreign investors are still on the hook to the US government for $2.37tn. Is the lower amount of credit from abroad a problem for the US government? Not at all, analysts say. With Americans saving more of their own incomes amid an uncertain economic outlook, Washington is able to borrow more at home. "A higher US savings rate implies more such purchases from domestic investors," says Ms Ziemba at RGE Monitor.