Thursday, October 09, 2008

Why I Am Not Smart Enough to Write Op-Eds for the Financial Times (for R. Taggart Murphy)

Arvind Subramanian of the Peterson Institute of Economics has made an interesting suggestion:

Ken Rogoff of Harvard cheekily characterised the vast Chinese accumulation of US Treasury bonds over the past five years as the biggest foreign assistance programme in history. Why not push that further? Here is a thought experiment.

The Chinese government could offer to lend up to $500bn (from its current stock of $1,800bn) to the US government for the rescue of its financial sector. Its previous assistance – buying US bonds – was indirect and unconditional. Not so in this case.

China's loan offer would be direct to the US government to be spent in the current financial crisis. More important, it would come with strings attached. Tied aid, the preferred mode of operation of western donors since the postwar period, would now be embraced by China.
Wait a minute, let me try to reason this one out.

Subramanian is suggesting that China ("Japan" might just as well be inserted here) bailout the U.S. financial sector with its currency reserves...which are held, for the most part, in the form of U.S. Treasuries and Agencies (i.e., bonds issued by Fannie Mae and Freddie Mac)...meaning that China will be lending to the U.S government...the I.O.U.s of the money it has already lent the U.S. government.

I do not understand this at all.

I guess this is why I am not smart enough to write Op-Eds for the Financial Times.


Janne Morén said...

It works, actually. The bonds have a value - the money due as they come due, minus some risk premium due to the chance that the issuer may not actually pay back. The bonds represent real money, no matter who you'd give them to. The bonds represent a hole, a negative amount, for the issuer who has to pay them back at some point, and loaning them to the issuer means the hole temporarily gets filled. Essentially, USA would get an extension on the bond principal due dates.

See it this way: assume Chine gave the bonds to US not as a loan, but simply as payment for something (to buy the Washington monument, perhaps, or Alaska). Effectively, the US would now owe that bond money to itself - they would not have to pay it back anymore in other words. They'd go from having a future $500 billion debt to $0. Which is just as good as going from $0 to +$500 billion.

MTC said...

Herr Morén -

China's currency reserves are sterilized, meaning that all the I.O.U.s it holds from the U.S. are matched to I.O.U.s the People's Bank of China owes the Chinese people, plus several hundred billion yuan due to currency appreciation.

How does the Chinese government repay the debt it owes to its own citizens?

Chris ( said...

Is the argument not this:

- The Chinese have a USD asset (treasuries), which has been sterilised by the sale of Yuan paper to the people (banks).

- They have the opportunity to swap that USD asset for another USD asset - whether it be toxics, bank equity/prefs, or something else that would "help" the US.

- The US gets a problem off its balance sheet, and the Chinese get an asset which yields better than US treasuries, in turn helping them to turn around the losses they have been making on sterilisation ever since yuan bond yields pushed above USD yields. And helping their largest trading partner to stay solvent.

I'm probably missing something, but this was the only way I could read sense into Subramanian's proposal.

RMilner said...

Surely some of the foreign reserves are actual dollar banknotes.

MTC said...

Brad Setser ( ) seems to believe that in People's Bank of Chinaspeak, the phrase "Other foreign assets" means bank deposits in foreign currency.

Though the latest statistics availabel on the PBoC website( ) are from last December and in yuan, the indication is that China might have enough currency on hand on hand to be a big player in a bailout.

It would have been nice for Subramanian to have a line in essay on what class of asset he was hoping the Chinese might lend the United States.