Friday, March 20, 2009

Whither China?

This weeks announcement that the Fed will push interest rates yet lower raises a number of trillion dollar questions. Among them is what will the Chinese do with current holding in US Treasury Bonds and Mortgage backed securities and what will they do with new reserves?

The Fed announcement will push interest rates to unnaturally low levels which in time will snap back, unless the financial system is so broken there is no normal anymore. Leaving aside that possibility for the moment what about the trillions of dollars in china's hands?

Firstly for the treasury bonds they hold, this move is a gift. There asset value has risen remarkably and now they must consider whether moving some of those bonds out of the portfolio wouldn't make sense. It would be very "un-chinese" to move rashly so I do not expect we will see sales of any magnitude prompted by a policy change. However, going forward locking in unnaturally low rates of interest likely is not in chinese interest.

How will china use and protect its huge asset? Part of that question is being answered already as we have witnessed massive hard asset investment in the past two months. Mining operations, energy resources and domestic infrastructure stimulus have all stepped forward.

Years ago when trading physical commodities, when China entered (or stepped out of) a market whether steel, copper or nickel the effects were powerful. We will be watching china's steps for clues of direction, duration of their money flow.

John Barnyak