By all accounts China's Prime Minister, Wen Jiabao, is an intelligent man. Therefore he knows that China will lose a substantial portion of its investment in U.S. Treasury bonds. This raises the question of why he is complaining about the risks in China's holding of U.S. Treasury bonds, when he knows that there is no risk, the investment is a sure loser. The loss will come for two reasons. First, the United States is running a large trade deficit. The only way that this surplus can be sustained is if the Chinese government and other central banks continue to buy up ever more U.S. dollars, thereby preventing the currency from falling. If the Chinese government ever stops buying vast amounts of U.S. dollars, the dollar will fall in value against other currencies (as it did in the years 2002-2007) causing China large losses on its holdings. But, this loss is China's decision, not the result of U.S. government policy. As long as China wants to spend hundreds of billions of dollars each year propping up the dollar, it can prevent losses on its prior holdings due to a fall in the value of the dollar, but there would be no reason for Mr. Wen to complain about a policy that he or his successor will decide. China will also lose money on its bonds because the interest rate on U.S. Treasury bonds will almost certainly rise as the economy recovers. The Congressional Budget Office projects that the yield on 10-year Treasury bonds will rise from 3.0 percent today to 4.8 percent in a few years. This would imply a loss of about 15 percent in the value of a 10-year Treasury bond. For these reasons, Mr. Wen knows that China will lose money on its Treasury bond holdings. The news reporting on his comments should be asking why he is complaining about the risk of losses that he knows are virtually certain.
--Dean Baker
