Why China Affects Your Mortgage Payment
So the PBOC takes the dollars in exchange for local currency. What does the PBOC do with the dollars?
They want to invest the money, so they can make money on it. And they've been buying huge amounts of U.S. government securities. They have about $1 trillion in foreign-exchange reserves. About 70 percent of it goes into U.S. securities. About half of that is U.S. treasury securities, with other investments in things like Freddie Mac and Federal Home Loan Bank Board securities.
Why U.S. treasuries?
Because they are risk free. There is no credit risk associated with them. It's the safest investment in the world. The U.S. government can always raise taxes to make the interest and principal payments, and the Federal Reserve can also print money.
Are they long-term or short-term treasuries?
We don't really know. It's not all that clear. What we do know is that if the U.S. national debt is about $8 trillion, and that's financed through treasuries, and China holds about $350 billion worth of treasuries, then they're financing 4 to 5 percent of our national debt.
Where does the PBOC invest the other 30 percent?
Mostly assets denominated in the euro, the Japanese yen, and the Korean won.
Has China always put roughly 70 percent of its reserves into U.S. securities?
It's been that way for a while, although remember, their reserves are going up rapidly. Also, there's been concern for some time because Chinese officials have said they want to diversify, which means they might reduce their holdings of U.S. securities. But if there's a big shift coming, we haven't seen it yet.
That huge Chinese investment in the United States–how does it affect the U.S. economy?
It keeps interest rates low, because there's a broader demand for our securities. If they were only marketed in the U.S., we'd say, "Well, we don't want to buy that many, unless the interest rate goes up." Think of it this way. If the treasury has $1,000 of debt that it wants to sell, and there's only one purchaser, he's likely to say, "I only want part of it. I don't want all of it, unless you raise your interest rate." But then, if you can get more people to buy it, you don't have to raise your rate.
Does that mean that interest rates are lower than they otherwise would be, on account of China's demand for U.S. debt?
Well, in the early 1980s we had double-digit interest rates–and we didn't have China purchasing our debt. So, yes, China is helping keep our rates down.
Treasury rates are one thing, but mortgage rates, and other interest rates that consumers pay, those are different. Explain how they're related.
The lowest interest rate in the market will always be the risk-free rate. Other rates will be higher. The differential represents the risk of default. So if I'm a bank, I say, "I can invest my money in treasury securities, at the lowest possible rate, or I can make a loan to Jim. But Jim has a higher risk of defaulting, so we'll raise his rate." But if you raise the rate too much, somebody else in the market will bid you down until the rate represents the best estimate of the risk of default. If there were only one lender, there could be lots of gouging. But there's always somebody willing to shave a point or two because they think they know more about the risk of default.
advertisement
