The Symbiotic Relationship Between the Chinese and the U.S. Treasury Bond

I bet that just about everyone reading this has also read and heard elsewhere that the Chinese are America's biggest debtor. Often following such a pronouncement is often a misguided and naive rant that is long on political rhetoric and very short on sophisticated financial knowledge. The reality is that Chinese being America's biggest creditor creates a symbiotic relationship that means that the Chinese become partners with the U.S. In fact, in many ways, the Chinese are put in just as precarious position, if not more, as the U.S. as a result.

The best estimate put us into debt to the Chinese to roughly one trillion Dollars. The U.S. Treasury bond is mechanism by which the Chinese become our creditors. That's of course because that's how the U.S. government borrows money. The U.S. Treasuries are traded like any other security on the open market. While I don't have their books in front of me, I would assume that for the most part their investment is in the 10 year U.S. Treasury. That's because the 10 year is the most popular and actively traded of the Treasury Bonds.

By holding on to so much U.S. Treasuries, the Chinese have in effect made themselves more dependent on the U.S. Treasury Bond itself than our government is on the Chinese. That's because the U.S. Treasury Bond is both a tool of income and of investment. As the interest rate goes up, the worth of the bond goes down. As such, the Chinese have a significant vested interest, about a trillion Dollars worth, in doing everything they can to make sure that the rate on the Treasury bond stays as low as possible.

As such, here is what the Chinese leader, Wen Jiabao, said today.

Speaking ahead of a meeting of finance ministers and bankers this weekend near London to lay the groundwork for next month’s Group of 20 summit meeting of the nations with the 20 largest economies, Mr. Wen said that he was “worried” about
China’s holdings of United States Treasury bonds and other debt, and that China was watching economic developments in the United States closely

.

He should be worried. That's because as the U.S. borrows more and more money, that puts upward pressure on the rate on the bond. The more the U.S. borrows, the more the Chinese will have to buy up these new bonds, if for no other reason, then to protect the investment they already have. By investing even more, the Chinese are married even more to the bond. They have already committed the first cardinal sin of investment, putting too much into one investment. Yet, their investment is so large that to the Chinese it's even worse. With each successive investment into the bond, the Chinese have even more riding on the investment. As such, they are that much more indebted to continue investing or face the real possibility of losing serious investment wealth.

Here's the dirty little secret that the Chinese are almost certainly well aware of. The U.S. Treasury Bond has a perfect 100% payback, but here's how they pay back each and every time. The U.S. Treasury issues even more bonds. It is in effect a house of cards. It's a house of cards that the Chinese have taken a significant position into. As such, if it were to crumble, with it, would about a trillion Dollars worth of Chinese investment as well. For this reason, the Chinese have just as much riding on the deal as the U.S. does. It is a symbiotic relationship.