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March 3rd 2009

China Looking to Buy Oil & Diversify from US Treasuries

US Treasury yields have been held low across the short-term and long-term due in part to a lack of appealing investment opportunities in a deflationary period, while the Federal Reserve announced in January the possibility of buying long-term US government Treasury bonds to help hold down long-term interest rates (and thus mortgage rates), hoping for a slow controlled decent in housing prices.

At the other end of the spectrum, the US government has been bailing out every large financial institution willing to accept a few billion here or there, and running the printing presses in overdrive.

Chart of U.S. Money Supply Growth

Eventually this will lead to inflation, as explained by John Williams last August:

Excess supply of a commodity or product usually is reflected in downside pressure on its price, and the same is true for money. Excessive supply of money leads to its debasement, to a decline in its value that otherwise is known as inflation. Where money supply generally is an underpinning of economic activity, it also is the ultimate determinant of prices and inflation. At present, near-record high annual growth in the broadest U.S. money measure M3 is suggesting a significant inflation problem in the year ahead.

The Chinese have nearly 2 trillion Dollars in their reserves, with roughly 2/3 of them being denominated in US Dollars. Seeing their own economy slow, and the coming risk of inflation, the Chinese government is looking to shift some of their reserves away from US Dollars to hard commodities, particularly oil. Marketwatch reports:

China is considering plans to tap its foreign reserves to buy crude oil as part of a push to diversify holdings from U.S. Treasurys, according to a published report.

With the U.S. issuing massive amounts of government bonds to finance economic stimulus measures, Chinese officials are looking to hedge against the risk of Treasury prices dropping.

China, which has been building up a national oil stockpile since 2004, aims to amass 100 million barrels by next year as a first step, the Japanese business daily Nikkei reported.

This may just be jawboning to try to slow down the US printing presses, but if it is more than that, it could have a significant effect on the perceived value of the US Dollar, especially in light of the current $1.75 trillion US deficit – a full 12.3% of the projected 2009 GDP. If foreigners lose confidence in the US Dollar, inflation and interest rates will certainly move sharply off their historic lows as the risk of “risk free” US treasuries is revealed and repriced.

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4 Comments of “China Looking to Buy Oil & Diversify from US Treasuries”

  1. Lokes Says:

    I don’t think there will loss of confidence in the US Doller. May be the present situation prevail for few months then after it is seeing its way to progress.

  2. AutopilotFX Says:

    But China is a big country with big potential. I read the book “Why We Want You To Be Rich” by Robert Kiyosaki/Donald Trump and they also see the huge potential China and India in the new economy. I’m not an expert but somehow I believe the threat is there.

  3. InflationHedge Says:

    I agree with your thesis on inflation. As the economy begins to recover (which doesn’t seem to be anytime soon), China and other large holders of Treasuries will diversify away, causing significant downward pressure on the dollar.

    The link is to another good article on the US dollar.

  4. China Ready to Diversify: Oil Investments Represent Shift to Commodities | Genuine Forex Trading Says:

    […] diversify its investments. Such a move could be harmful to the US dollar in forex trading, though. The Forex Blog explains what could happen if China does abandon its large amounts of US notes: This may just be jawboning to try to slow down the US printing presses, but if it is more than […]

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