The China Effect

How will China’s Investment Policy dramatically impact the United States, economic recovery, and the real estate market?

China’s Investment Policy has dramatically changed. According to Joe Quinlan, chief strategist at U.S. Trust, China will reduce its purchases of U.S. Treasuries from over $100 Billion last year, to about $55 Billion this year. The remaining money, or about $55 billion, is being invested in “hard assets,” or in assets like iron, oil and copper, in lieu of U.S. treasury bonds.

This reduction is seen as part of its currency strategy.  The Yuan, china’s currency, is undervalued against the dollar by as much as 40%. If the Yuan rises in value, any interest payments received by China on Treasury Bonds, is offset by the loss in value of the dollar occurring from QE2. This makes investing in the dollar unattractive to the Chinese Government.

Additionally, China is already concerned about the credit-worthiness of U.S. debt. (Consider the EU with Greece and Ireland, and similar economic and banking challenges.) QE2 spending by the Fed, has only hastened China’s flight from Treasury Bond purchases because the Chinese believe QE2 amounts to just merely printing money.

Conversely, China has a vested interest in the U.S. economy staying healthy because:

• It holds almost $1 Trillion in U.S. debt.
• The U.S. consumer is a significant purchaser of Chinese exports.

 

With this major source of Treasury Bond purchases dwindling, the “China Effect,” where China reduces its purchases of U.S. Treasuries, will eventually put upward pressure on interest rates in the U.S. and will also make economic growth in the U.S. more difficult.  How will higher interest rates and slowing economic growth impact the housing recovery?  We have not yet seen the impact of China’s reduction because the effect has been overwhelmed by the massive purchasing of U.S. Treasuries by the Federal Reserve under QE2.

 

The long-term impact on the United States could be far worse. The Director General of the Ministry of Commerce in Beijing states that, “as China upgrades its industries, China is aggressively pursuing investments all over the world.”  For the first time last year, China purchased more assets in the United States, than the U.S. did in China.

 

Superpower status comes from great military and economic strength. With trillions of dollars to invest, China is rapidly turning the tables on U.S. economic superiority.