China Bought More Treasuries Than Disclosed, Perhaps Illegally; Nuclear Dollar Dumping Theory Revisited
Not only did China buy more treasuries than disclosed, it did so in violation of treasury auction rules.
When the Treasury Department revamped its rules for participating in government bond auctions two years ago, officials said they were simply modernizing outdated procedures.Direct vs. Indirect Bidding Comparisons Invalid
The real reason for the change, a Reuters investigation has found, was more serious: The Treasury had concluded that China was buying much more in U.S. government debt than was being disclosed, potentially in violation of auction rules, and it wanted to bring those purchases into the open - all without ruffling feathers in Beijing.
The United States sells its debt to investors through auctions that are held weekly - sometimes four times per week - by the Treasury's Bureau of the Public Debt, in batches ranging from $13 billion to $35 billion at a time. Investors can buy the bonds directly from the Treasury at auctions, or through any of the 20 elite "primary dealers," Wall Street firms authorized to bid on behalf of customers. The Treasury limits the amount any single bidder can purchase to 35 percent of a given auction. Anyone who bought more than 35 percent of a particular batch of Treasury securities at a single auction would have a controlling stake in that batch.
By the beginning of 2009, China, which uses multiple firms to buy U.S. Treasuries, was regularly doing deals that had the effect of hiding billions of dollars of purchases in each auction, according to interviews with traders at primary dealers and documents viewed by Reuters.
Using a method of purchases known as "guaranteed bidding," China was forging gentleman's agreements with primary dealers to purchase a certain amount of Treasury securities on offer at an auction without being reported as bidders in that auction, according to the people interviewed. After setting the amount of Treasuries the guaranteed bidder wanted to buy, the dealer would then buy that amount in the auction, technically on its own behalf.
The practice kept the true size of China's holdings hidden from U.S. view, according to Treasury dealers interviewed, and may have allowed China at times to buy controlling stakes - more than 35 percent - in some of the securities the Treasury issued.
The Treasury department, too, came to believe that China was breaching the 35 percent limit, according to internal documents viewed by Reuters, though the documents do not indicate whether the Treasury was able to verify definitively that this occurred.
Guaranteed bidding wasn't illegal, but breaking the 35 percent limit would be. The Uniform Offering Circular - a document governing Treasury auctions - says anyone who wins more than 35 percent of a single auction will have his purchase reduced to the 35 percent limit. Those caught breaking auction rules can be barred from future auctions, and may be referred to the Securities and Exchange Commission or the Justice Department.
At the beginning of 2009, Treasury officials began discussing the issue of guaranteed bidders, with a focus on China's behavior, internal documents seen by Reuters show. The culmination of their efforts was a change to the Uniform Offering Circular published on June 1, 2009 that eliminated the provision allowing guaranteed bidding.
In the first auctions conducted after guaranteed bidding was banned, a key metric rose sharply: the percentage of so-called indirect bidders, those who placed their auction bids through primary dealers. Indirect bidders are seen as a proxy measure for foreign central bank buying, because foreign central banks most often bid through primary dealers. With the elimination of the guaranteed bidder provision, far more buyers were put in this class in reports to the Treasury Department.
As a result of the rule change, comparisons of direct and indirect bidding now to a few years ago are invalid. Foreign governments were buying more US debt before than they disclosed.
Sadly, the article perpetuated widely spread nonsense regarding China dumping of US debt:
"If the Chinese sold their Treasuries all at once, it could undermine U.S. markets and the economy by driving interest rates higher very quickly. Scenarios of this sort have been discussed in Washington defense-policy circles for at least a year now. Not knowing the full extent of these holdings would make it even more difficult to assess China's political leverage over U.S. finances."
The irony was China was buying more than disclosed, while the fear was otherwise. China can still be accumulating more US debt than disclosed via the secondary markets and possibly via foreign markets.
Secret Treasury Buying
Flashback January 21, 2011: China Secretly Buying US Treasuries Via UK Accounts? Trade Deficit Math; "Hot Money" Math
Floyd Norris at the Wall Street Journal thinks China May Be Masking Its Purchase of U.S. SecuritiesChina's Treasury Holding Revised up 30%
Who Is Buying US Debt?
Here are two charts from the graphic: Who Buys U.S. Debt?
Foreign Buyers and Sellers
Trade Deficit Math
The two charts above are not believable for a mathematical reason that Norris did not explicitly state: When the US runs a deficit, some other nation must (as a function of pure math) accumulate US assets. Those assets could be dollar reserves, treasuries, investments in US companies, US property, or US equities.
One humorous aspect of all this alleged selloff of US treasuries by China is the hyperinflationist rant "China is Dumping Treasuries" when the reality is that China is likely accumulating US dollars or US treasuries a function of trade deficit math.
My one quibble with Norris' article is his statement "If China has been buying through money managers, it may be easier at some point for it to begin selling Treasuries through the British channel without others understanding where the selling pressure is coming from."
While technically true, please remember the math. Were the US to start running trade surpluses with China, then China certainly would be an outright seller of treasuries or US$ reserves. How likely is that?
On March 1, 2011, I noted China Holdings of US Treasuries Revised Up 30%
Annual revisions released Monday show that China's holding of US treasuries is 30% greater than reported just weeks ago.Silly Rumors Surface Constantly
I am not surprised given that persistent rumors of China dumping treasuries made little mathematical sense from a balance of trade standpoint. Instead, I suggested China was accumulating treasuries via trading desks in the UK. We now see that is precisely the case.
Nonetheless, rumors circulate consyantly that China is dumping treasuries or soon will dump treasuries causing soaring interest rates or hyperinflation in the US.
Nuclear Dumping Theory Revisited
For a detailed rebuttal to the silly "nuclear dumping" theory and belief China and Japan will refuse to buy US debt or hold US dollars, please see ...
- Should China Dump Dollars for Commodities? What about the "Nuclear Option" of Dumping Treasuries? Can Global Trade Collapse?
- Hyperinflation Nonsense in Multiple Places
Mike "Mish" Shedlock
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