What’s China going to do?

on Aug 12 in Economics tagged by Trevor Hicks

John Mauldin asked a thought provoking question recently wondering what China will do with it’s $2.2 trillion in US government bonds.

The US is clearly on an unsustainable path with it government debt. As we issue more and more bonds and print more and more money, the value of our bonds is sure to drop over time. US bonds have maintained high prices (and low interest rates) because of the global crisis. Our bonds are kind of the least crappy asset to own in the financial world but this won’t always be the case. China is in a bind - when you or I sell stocks or bonds we don’t move the market. But China owns so much US debt that they can only unload small portions without causing the value of their portfolio to plummet.

Now China is sure to continue to pile up reserves as they are still an export dominated economy. If you don’t know, one if the ironclad mathematical laws of international capital flows is that when you run a trade surplus with another country, you have to invest the difference in that country. China is going to keep building stuff for us to buy and consequently will keep buying US assets in exchange.

I dint think China will want to keep accumulating paper assets like bonds - I suspect they will start to pursue more real assets, much like the Japanese did in the late 80s. My expectation is that the purchase if Hummer is only the beginning - more US based companies and real estate will become Chinese property over the coming decade.

As Mauldin suggested, the profit opportunity for us is to figure out in advance what they’ll want to buy and get in first.