According to reports, on November 7, 2016, debt held by the United States of America public was $14.3 trillion or about 76% of the previous 12 months of GDP.
Intra-governmental holdings stood at $5.4 trillion, giving a combined total gross national debt of $19.8 trillion or about 106% of the previous 12 months of GDP…. $6.2 trillion or approximately 45% of the debt held by the public was owned by foreign investors, the largest of which were China and Japan at about $1.25 trillion for China and $1.15 trillion for Japan as of May 2016.
By any standard, other lesser country would have been declared bankrupt way before the trillion dollars mark but, of course, that’s not the case for a super power like the US because the world’s economy is still powered by the almighty US dollar.
However, for some reason or other, in Dec 2016, China sold $34bn worth of US government bonds raising fears that Beijing is using its financial muscle to signal that it has lost confidence in American economic policy.
US treasury figures for the period ending in December 2009 show that, following the sale, China is no longer the largest overseas holder of US treasury bonds. Beijing ended the year sitting on $755.4bn worth of US government debt, compared to Japan's $768.8bn.
So, if the reason for China to sell off some of her US treasury bond is not due to lack of confidence in the US economy, then what was the reason for doing so?
China’s economy grew over 12% per year in 2006-2008, and again in 2010. Even at the depths of the global financial crisis in 2009, annual Chinese growth was still over 6%. Chinese growth ran between 8% and 6.7% from 2011 to 2016.
But, beneath that glossy surface all is not well because much of China’s growth was completely artificial. China’s growth consisted of about 45% investments while those in developed economies are about 30%. Investment is great if they have positive expected returns and are not financed with excessive debt, but that seems to have been lost on China.
Much of China's investment is completely wasted on “ghost cities” (major metropolitan complexes that are completely empty), as well as white elephant prestige projects such as the multi-billion dollar Nanjing South train station with 128 mostly unused escalators. Assuming half of Chinese investment is wasted, then GDP should be reduced 22.5% which turns 6.7% growth into 5.2% growth at best.
The situation gets even worse when you consider the amount of debt being used to finance this wasted investment. China’s bank assets have grown from about $2.5 trillion to $40 trillion in the past 10 years, a 1,500% increase. And that’s just the tip of the iceberg.
Most of China's debt is “off the books” (commonly dubbed “shadow banking” system) in so-called wealth management products (something like the CDOs that sank Lehman Brothers in 2008), and derivatives.
The huge “shadow banking” system works on provincial guarantees, inter-company loans and offshore transfer pricing schemes. When all of this debt is taken into account, China looks like the greatest Ponzi scheme in history.
President elect Donald Trump has already called China the greatest currency manipulator of all time and he has plenty of reasons to say that.
China used a 35% “maxi-devaluation” of the yuan in 1994 to make its currency globally competitive and boost its exports. Then it used central bank intervention from 1994 to 2006 to keep its currency at that depressed level. This 12-year currency manipulation enabled China to build its factories, create jobs, pile-up dollar surpluses and prop up its banking system.
Since 2014, China has allowed the yuan to devalue from 6.0 to 1 dollar down to 6.9 to 1 dollar. Now China is again resorting to its currency wars playbook and the yuan is poised to break through the significant benchmark of 7.0 to 1 dollar.
With China heading for a credit crisis, and U.S.-China political relations strained, what does this portend for the Chinese yuan and a budding currency war?
Well, when Donald Trump take his oath of office as the 45th President of the United States of America on 20-Jan-2017, I am very sure China and the rest of the world will be watching to see what he will do during the first 100 days as the most powerful man on planet Earth….and we Forex Traders will like-wise be wringing our hands wondering whether to click on the “buy” or “sell” button for the almighty USD.
Good luck to one and all, Very Merry Christmas, and a profitable and prosperous New Year 2017....and may sanity prevail.