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The Chinese Are Selling Treasuries – So What Are They Buying?

In the monthly U.S. Treasury report this week, it was announced that China had sold $34.2 billion of Treasuries in December (or allowed short-term ones to run off), making Japan once again the largest holder of U.S. Treasuries.

The battle between China and Japan for the title of largest holder of this dubious asset is not very interesting. What's more interesting is the question of where China is instead opting to invest. After all, $34.2 billion is a fair chunk of change, and China's overall reserves are growing – not shrinking – and now total $2.4 trillion.

The People's Bank of China usually keeps its holdings a carefully guarded secret, much more so than for most central banks – our knowledge of its holdings of Treasuries comes from U.S. data, not from China.  We do, however, have some evidence about the Chinese government's investment thinking, thanks to the holdings of China Investment Corp., the country's $200 billion sovereign wealth fund.

CIC got heavily involved in the U.S. financial business in 2007, buying a $3 billion stake in The Blackstone Group LP (NYSE: BX) and a $5 billion stake in Morgan Stanley (NYSE: MS) – in both cases, 9.9% of the outstanding common. Neither of those investments turned out particularly well – Blackstone is down about 60% from CIC's buy price while Morgan Stanley is down about 40%.

More recently, CIC has turned toward natural resources, in 2009 buying 17% of Teck Resources Ltd. (NYSE: TCK) and 13% of Singapore-based Noble Group. Teck Resources is a major diversified mining company, while Noble is a global commodities trading/supply-chain manager with $36 billion in sales.

For CIC, the bad news is that because commodities companies have wimpy market valuations compared with the overstuffed titans of Wall Street, its investments in Teck and Noble were much smaller – $1.7 billion and $1.1 billion, respectively. Still, those investments have turned out a lot better – CIC's Teck investment is worth about 110% more than it cost and its Noble investment has risen about 60% – with both increases coming in less than a year.

So which do you think the Chinese government is motivated to invest in – the staggering titans of U.S. financial services or rapidly growing commodity producers? That's without taking into consideration the fact that China has an ever-increasing thirst for commodities, because of its rapid growth, whereas it has perfectly competent banks of its own.

Let's not get carried away. The People's Bank of China is a central bank, not a sovereign wealth fund, and it couldn't invest $2.4 trillion in Teck Resources shares if it wanted to (though the other Teck shareholders would doubtless enjoy the ride if it wanted to try!).

Still, look at the alternatives:

  • It could buy more Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) bonds. However, those are effectively guaranteed by the U.S. government and are subject to the risk of U.S. inflation and rising rates. Probably not.
  • It could buy euro bonds and bills. It already has a fair chunk of these, and probably doesn't want to increase its exposure while it's still not clear what will happen to Greece. One possible solution to the Greek problem would be Bernanke-esque money printing by the European Central Bank (ECB), which would zap the value of euro bonds; alternatively, if no solution was found, further countries could follow Greece into default.
  • It could buy British gilts. If it doesn't like the U.S. risks, it will really hate the British ones, which are the same, but worse.
  • It could buy Japan government bonds. With Japan running deflation at 2%-3%, the 2% yield on 10-year JGB represents a real yield of 4%-5%. So if you think Japan will sort itself out before defaulting, this is about the best deal in the market. But China is not big buddies with Japan.
  • It could buy Australian, Canadian or Swiss government bonds. All three are good deals in sound economies, but deploying $34.2 billion into any of them within a month is probably impossible.

So given that central banks don't generally buy stocks (that's what sovereign wealth funds are for), or dabble in commodity futures, there are really only two decent alternatives into which China could sink that amount of money: gold and silver.

China already owns some gold, but not much, compared to the size of its reserves – 1,054 tons at March 2009, worth about $37 billion at today's prices. At 1.5% of its reserves, that's pathetic, though it's up 76% since 2003. On average, international central banks hold 10.2% of their reserves in gold. To get to that level, China would have to buy more than $200 billion worth – about two years' global mine output.

Nevertheless, it seems unlikely that China will be willing to retain above average confidence in the eternal value of Western fiat currencies, and so it's probable that considerable Chinese gold buying is taking place on a confidential basis.

Silver is not is a significant part of most countries' reserves, but China is historically an exception, since in Imperial times it was on a silver standard rather a gold standard, and so retained substantial reserves. Early in the 2000s it was a major seller, selling 50 million ounces in each of 2001 and 2002, at the then-prevailing prices of below $5 an ounce. After that it stopped selling.

Then, in September 2009, the Chinese government passed a decree encouraging Chinese savers to buy silver, issuing publicity explaining that buying silver was a good deal since the gold/silver price ratio at 70-to-1 was historically very high, offering them convenient small-value ingots with which to buy it, and prohibiting the export of silver from China.

This was almost certainly a move designed to dampen stock-market speculation and reduce money supply growth, since bank deposits converted into silver would effectively be sterilized. What's more, if the long-awaited Chinese banking crisis ever happened, the effect on the long-suffering Chinese public would be mitigated if people held substantial wealth in the form of readily negotiable silver ingots.

In any case, it's likely that China as a whole – whether the government or its people – is now a very substantial buyer of silver, indeed, possibly to a greater extent than gold. Thus, a rundown in People's Bank of China holdings of U.S. Treasuries could be readily accounted for by purchases of gold for its own account and of silver to supply to the Chinese public.

China is not a universal fount of investment wisdom. But with this information, I know which way I'm betting.

 [Editor's Note: Martin Hutchinson has terrific foresight. He warned investors about the dangers of credit-default swaps – half a year before those deadly derivatives ignited the worldwide financial firestorm. Hutchinson even predicted where and when the U.S. stock market would bottom (a feat that won him substantial public recognition).

During the stock-market rebound that started in mid-March, Hutchinson's calls on gold, commodities and high-yielding dividend stocks made winners of investors who took his advice.

Experts are taking notice. And so should you.

Hutchinson is now making those insights available to individual investors. His trading service, The Permanent Wealth Investor, combines high-yielding dividend stocks, gold and specially designated "Alpha-Bulldog" stocks into winning portfolios.

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  1. clive miles | February 19, 2010

    Gold has so many tail winds it has to be a winning bet. It can be manipulated, but one of those few commodities that cannot be mismanaged as so many business leaders have proved to be.

  2. John | February 19, 2010

    Ever thought that they by Russian Rouble?

  3. Iain MacNicol | February 19, 2010

    Like the way they have transformed their economy from a feudal agricultural country into an industrial powerhouse paid for by the USA they show an amazing ability to manage their affairs and everybody should be aware that silver represents the best investment value in the world and will remain so for some time to come.

    • Ken Davies | February 25, 2010

      What exactly was "paid for by the USA"? Have a look at the financing of China's fixed investment during the last three decades of economic reform. Roughly 90% of it is from domestic savings. Of the rest, the biggest source of foreign investment has been Hong Kong, which includes an unknown quantity of round-tripping of domestic Chinese capital taking advantage of tax breaks for foreign investors, so the real proportion is even higher. Chinese consumers now benefit from low prices for Chinese goods because their country has borrowed up to the hilt from Chinese savers.

  4. JGBell | February 19, 2010

    This article is NOT telling U.S. what China is now doing, only speculating on what he thinks they might do.
    FIRST, what really matters is whether China is selling short OR long term TBills; and you have not answered that question. Bcuz, if China is betting on economy of U.S., they might sell long term low interest TBills and buy short term TBills, getting ready for US interest rates to climb.
    SECOND, now that the Fed Govt owns and guarantees FMae&FMac&SallyMae, and FHA, RE securties, AND given that the Chinese Yuan is "tied" to the value of the US$, China knows that they will NOT loose market share in U.S., and they can always buy goods and services from U.S. at "cost".
    So…, selling TBills, that are used to fund the Federal Deficit, makes very good economic sense; and then buying long term RE securities also makes sense for China.
    But, to ask YOU the question you did not answer: "What ARE they really doing?"

  5. distantvoice | February 20, 2010

    China is investing in Africa, a continent so needy yet so rich in assets. China thinks long term, and over the next 30 years they might revive parts of Africa while lining their own pockets, generating African economic stability, and possibly growth and power for the region.

    I don't believe China is taking the robber barron approach. They're benefitting while partnering. It's a win-win strategy. I'm 55 yrs old. If I live another 30 years I expect to see China has invested and built a sort-of Afro-China on the continent.

    Of course, lots can go wrong in Africa. But I think China is diving into it anyway. The article above makes it clear that China (and the rest of us) have few good investment options in this caustic environment.

  6. joe | February 20, 2010

    Anything that supplies energy to the very hungry chinese consumer ,oil,coal,gas,etc these companys that supply the above will not only return dividens to the investor but will guarantee a monopoly on the supply chain the one thing the chinese enjoy most ,gold/silver are the garantors for return.currency`s are the tools for trading the obove the end of the day the central govenment enjoys only one return -power-and Iam not talking about the light switch.

  7. E.L.Tuttle | February 20, 2010

    Gold to $3,400 an ounce.

  8. William | February 25, 2010

    So, help me understand. China sold $34 billion Treasuries in December in order to reduce their exposure to the weakening US$. Who did they sell them to???? What currency did they get in exchange for those IOUs? It seems to me that selling Treasuries exchanges US$ for US$. And since the dollars they got from this sale were then used to buy gold and silver, that should better establish the value of the dollar relative to those metals. While, Treasuries are becoming the Hot Potatoes because of the US Government's massive debt and likelihood of default.

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