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U.S. or China: Who is Funding Whom?

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Executive Summary:

  • China owns $1.2 Trillion of U.S. Treasuries
  • China companies traded on U.S. exchanges are valued at $4.7 trillion
  • Neither country would appear to benefit from a funding war.
  • Solution to trade war is critical to our long term bull market thesis.

We constantly hear that China is funding the U.S. deficit by purchasing over $1.2T of treasury debt. What is not talked about is the fact that the U.S. is funding Chinese companies. As of the end of April 2019, the market capitalization of U.S. listed China stocks was $4.7 Trillion. The risk is that China stops buying our debt or sells our treasuries off. However, would China risk having their corporate funding source cut off? So, who is funding whom? It would appear that funding is a stalemate and would be best for China and U.S. to find a trade solution.

Exhibit 1. Who is funding whom?

QID China Funding

Source: Morningstar Direct and People’s Bank of China

 

Granted that China’s investment into U.S. treasuries is from their central bank. These excess reserves are driven from their attractive trade surplus position. As of 2019 China was reported to have $3.1Trillion in foreign reserves, approximately one-third invested in U.S. Treasuries. I am sure that China could find other sources for their investment but how many are as safe and liquid as the U.S.? According to MarketWatch, see exhibit 2, the U.S. is one the highest yielding 10 year bonds available from a high credit quality country. Of the countries with AA credit quality or better only the United Arab Emirates has a higher yield at 2.75% vs 2.39% for the U.S. Singapore at AAA also has an attractive yield at 2.15%.

Exhibit 2. Country Yields on 10 Yr Debt or equivalent

QID Bond Chart

Source: Market Watch

 

If China starts selling off massive amounts of U.S. Treasury, the dollar would most likely depreciate. China’s Yuan would most likely appreciate causing the cost of their goods to increase and become more expensive for their trading partners. China could take the sale proceeds of U.S. treasuries and invest it back into local projects to reduce the impact to its economy or it could incur a dramatic devaluation to stay competitive. None of the options appear appealing but in economic wars I don’t believe rational actions are the expected.

The difference for the U.S. is that stock investment in Chinese firms is investor led not government initiated. U.S. investor’s want access to Chinese companies that will most likely be the major beneficiaries of their 1.7 billion population’s purchase of goods and services. In addition, our firms want access to the Chinese economy as it is expected to become the largest in the world as the standard of living improves over time.

The failure to fund each others needs is not a suitable solution. Near term, China’s sale of U.S. treasuries would have an immediate impact to U.S. markets. However, longterm, the loss of high tech components, equity capital and a key market would also negatively impact China. The most likely outcome would be a global recession.

China’s current holdings of US Treasuries is down $60 billion in the last couple of months. Supposedly, China is selling some treasuries to use the proceeds to support its currency. However, holdings are down $180 billion from their all time high. The impact to our interest rates to-date has been minimal as no one is questioning our economy’s viability.

We continue to view the tariff war as the largest risk to our long-term bull outlook.

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QID Who is Funding Whom

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