Wednesday, August 08, 2007

China: We have powerful reserves... You're going to regret this

China believes their reserves are now the ultimate power in the universe, and some are suggesting they use them.

According to this story, China is threatening to use its huge dollar reserves as a weapon to counteract protectionist rhetoric from Congress. This was given as a reason for the sell-off in Treasuries today.

I've written on the Asia effect on rates before.

The Telegraph story calls this the "nuclear" option. I think that term is apt. There are several parallels to launching a nuclear attack.

1) Both will cause devastating damage to the target nation.
2) There will be repercussions for the attacker, e.g., political, economic etc.
3) Nations tend to use threats like this as leverage, perhaps never intending to use them.

What would happen if China tried to crush the dollar? First of all, U.S. interest rates would rise substantially. U.S. consumers would have less purchasing power, both because financing would be expensive and because foreign goods would become pricier. As a major exporter to the U.S., a weaker U.S. consumer would not be in China's best interests.

I think the unwinding of the flight to quality has a lot more to do with today's Treasury sell-off. I know the auction didn't go so well, and some people were claiming that was China-related. But with spread product ripping tighter, and the Fed sounding pretty damn hawkish, rates are still too low.


Chris said...

"spread product ripping tighter"

don't believe the hype.

try getting a bid on a cmo or cmbs or most any other cash bond.

Accrued Interest said...

I'm not in the office today. Are things really bad in the corp market?

Chris said...

Giving back some of yesterday's tightening. ECB pumping 130 billion of liquidity. 1m Libor now at 5.54%
We've got trouble...
right here in River City!

"Liquidity problems make it impossible to establish a NAV"

HoosierDaddy said...

Well, homeowners with ARMS (and the Banks/Hedgies who lend to them) will be screwed. Banks and Hedgies that hold fixed rate paper will be screwed. Are you detecting a theme?

I'd imagine the retaliations back and forth could get really ugly really fast.