China Needs U.S. Guarantees for Treasury Bond Holdings, Yu Says

Feb. 11 (Bloomberg) -- China should seek guarantees that its $682 billion holdings of U.S. government debt won’t be eroded by “reckless policies,” said Yu Yongding, a former adviser to the central bank.

The U.S. “should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way,” Yu, who now heads the World Economics and Politics Institute at the Chinese Academy of Social Sciences, said in response to e-mailed questions yesterday from Beijing. He declined to elaborate on the assurances needed by China, the biggest foreign holder of U.S. government debt.

Benchmark 10-year Treasury yields climbed above 3 percent this week on speculation the government will increase borrowing as President Barack Obama pushes his $838 billion stimulus package through Congress. Premier Wen Jiabao said last month his government’s strategy for investing would focus on safeguarding the value of China’s $1.95 trillion foreign reserves.

China may voice its concerns over U.S. government finances and the potential for a weaker dollar when Secretary of State Hillary Clinton visits China on Feb. 20, according to He Zhicheng, an economist at Agricultural Bank of China, the nation’s third-largest lender by assets.

“In talks with Clinton, China will ask for a guarantee that the U.S. will support the dollar’s exchange rate and make sure China’s dollar-denominated assets are safe,” said He in Beijing. “That would be one of the prerequisites for more purchases.”

Chinese Foreign Ministry Spokeswoman Jiang Yu said yesterday that talks with Clinton would cover bilateral relations, the financial crisis and international affairs, according the Xinhua news agency.

Treasury Returns

U.S. government bonds returned 14 percent last year including price gains and reinvested interest, the most since rallying 18.5 percent in 1995, according to indexes compiled by Merrill Lynch & Co. Concern that the flood of bonds would overwhelm demand caused Treasuries to lose 3.08 percent in January, the steepest drop in almost five years, Merrill data show. The yield on the benchmark 10-year U.S. Treasury has risen to 2.83 percent from 2.21 percent at the end of last year.

China’s loss of more than $5 billion from investing $10.5 billion of its reserves in New York-based Blackstone Group LP, Morgan Stanley and TPG Inc. since mid-2007 may increase its demand for the relative safety of Treasuries.

“The government will be a net buyer of Treasuries in the short-term because there’s no sign they have changed their strategy,” said Zhang Ming, secretary general of international finance research center at the Chinese Academy of Social Sciences in Beijing. “But personally, I don’t think we should increase holdings because the medium- and long-term risks are quite high.”

Currency Reserves

China’s foreign-exchange reserves, the world’s biggest, grew about $40 billion in the fourth quarter, the smallest expansion since mid-2004 as an end to yuan appreciation since July prompted investors to pull money out.

The world’s third-biggest economy grew 6.8 percent in the fourth quarter, the slowest pace in seven years. Policy makers cut interest rates by the most in 11 years and announced a 4 trillion yuan ($585 billion) economic stimulus plan in November to spur domestic demand.

Yu said China won’t channel its reserves toward stimulating the economy because its trade surplus is sufficient to fund any import needs. China’s trade surplus was $39 billion in December, the second-largest on record.

A decline in reserves “isn’t likely because of China’s huge twin surpluses,” Yu said. China “should diversify its reserves away from U.S. Treasuries if the value of China’s foreign- exchange reserves is in danger of being inflated away by the U.S. government’s pump-priming,” he said.

Linking Disputes

China may try to link trade and currency policy disputes to its future investment in Treasuries, said Lu Zhengwei, an economist in Shanghai at Industrial Bank Co., a Chinese lender partly owned by a unit of HSBC Holdings Plc.

U.S. Treasury Secretary Timothy Geithner accused China on Jan. 22 of “manipulating” the yuan to give an unfair advantage to its exporters in the global market. The currency has dropped 0.14 percent since the start of this year to 6.8326 per dollar, following a 21 percent gain since a peg against the dollar was abandoned in July 2005.

“China can also use this opportunity to get a promise from the U.S. not to make inappropriate requests on bilateral trade and the Chinese yuan,” Lu said. “We can’t afford more yuan appreciation as the economy is facing a serious slowdown.”