Senior Asia economist, BNP Paribas
The real question here is can Asia aggressively move out of US Treasuries? A combination of strong foreign direct investment inflows, a tightly managed exchange rate and other structural factors has resulted in China, for example, running a persistent and large current account surplus and accumulating US$3 trillion in reserves (60% of Asia ex-Japan’s total).
None of the factors that have led to this build up look likely to fade soon, meaning China’s reserves will continue to grow quickly.
For China to become a net seller of treasuries it would have to find a home for more than US$600 billion of reserves per year in the coming years. Options are relatively limited. One alternative is moving up the risk spectrum of US dollar assets into corporate bonds, equities or real assets. This presents challenges, such as adopting a more active approach to portfolio management.
Buying of real US dollar assets will also run up against political objections in the US. And China’s overall US dollar exposure would, of course, be unchanged.
The alternative is to accumulate more non-US dollar assets. The Chinese authorities have argued for the greater use of IMF Special Drawing Rights (SDR), which is effectively a basket of the US dollars, euros, Japanese yen, and British sterling.
However, outstanding SDRs amount to only 3.5% of global reserves so there would have to be a major expansion of SDRs in circulation for this to be an option. This would require an 85% majority of the IMF governors, giving the US and EU an effective veto.
Straight diversification into other international currencies carries risks. Debt concerns continue to simmer within the Eurozone while the Japanese government debt trajectory is unsustainable.
With its foreign exchange reserves set to expand further for the foreseeable future, China will have little choice but to continue to add to its already uncomfortably large treasury holdings.
Chief economist, Asia-Pacific, ANZ
We do not think that Asian central banks can move aggressively out of US Treasuries owing to concerns about the sustainability of US debt, or any other issue. There is an ongoing gradual move, but a wholesale dumping of US assets is in no one’s economic interest.
First, one should note that Asian central banks are not forced to intervene in the currency markets, building ever-higher reserves to slow the appreciation of their currencies. While they may claim to be ‘smoothing volatility’ the fact that reserves continue to increase means that they are not smoothing it in a neutral fashion.
Such currency intervention is aimed at keeping currencies relatively weak, which is clearly aimed at maintaining export competitiveness. Whilst we can debate the extent to which currency levels affect exports (in our view foreign demand is a much more important factor), it remains the fact that at least part of the central banks’ reserve accumulation is the result of the view that exports are necessary for growth.
How do Asian central banks work to ensure that foreign demand remains robust? They buy US Treasuries. Even if these instruments are seen as a somewhat tarnished safe haven asset owing to US public debt concerns, buying Treasuries still holds down US yields and thereby increases the purchasing power of US consumers who have the largest wallet of any consumers worldwide.
But we are not living in a world of absolutes. Central banks are – and should – continuing to diversify their reserve holdings in terms of both geographies and asset classes. And concerns about the US fiscal dynamics are warranted.
So we will continue to see Asian (and other) central banks continue to move away from US Treasuries at the margin. But the symbiotic relationship is such that a wholesale, aggressive move out of treasuries is not a viable option at present.
Head of market strategy, RBS Securities
The premise – the US is struggling with its levels of debt – is wrong. While Federal Government deficit is hovering at an uncomfortably high 10% of GDP, borrowing by other entities is weak. Households are paying down debt and business borrowing remains weak.
Today, many companies are relying on internal funds instead of external borrowing to finance new investments. Likewise, state and local government borrowing is constrained by legal limits on their deficits. The bottom line is that overall debt levels in the US are not excessive. A recession-induced slowdown in private borrowing has made room for the headline-grabbing increase in federal government deficits.
Even so, over the long run, the US is not immune to the problems facing sovereign issuers whose debt is excessive. Projections by the Congressional Budget Office suggest that unless something is done, the deficit will approach unsustainable levels over the next decade.
What needs to be done has become increasingly clear. Discretionary spending and entitlements, especially those driven by escalating medical costs, must be brought under control. Social security can be adjusted because people are working longer as well as living longer.
On the revenue side, the Bush-era tax cuts can be allowed to sunset in 2012 as scheduled, and there are plenty of loop holes to close in the US tax code.
Investors should take heart these issues are finally getting a political airing. They should not be spooked when the debate inevitably heats up in the run up to the 2012 presidential election. The political process isn’t pretty but it is necessary to get a handle on the deficit.