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Thursday, June 20, 2019

China has started to sell US treasuries. - Part 4

https://www.reuters.com/article/us-usa-treasury-securities/china-holdings-of-us-treasuries-in-april-skid-to-nearly-two-year-low-idUSKCN1TI2RA

China had sold US treasuries again.  Why?

We've stated the rationale behind the selling in our previous posts.

http://sg-stock.blogspot.com/2019/05/china-has-started-to-sell-us-treasuries_18.html

The US treasuries sold off was not a retaliation against the US but to defend the RMB.  This is the reason the RMB is unable to breach the $7 mark.

What are the repercussions for selling the US treasuries?

China will have to convert the USD abroad into RMB and remit it back to China. This will cause an influx of RMB in China and increase the money supply.  As idling money will depreciate in value over time, the China central bank will make good use of the excess money by reducing the bank's required reserve ratio to stimulate its local consumption.

http://sg-stock.blogspot.com/2019/05/how-china-rrr-cut-will-impact-its.html

Thereafter, the excess money will flow into the stock markets, property markets, etc and boost inflation.  Consequently, inflation will help to reduce the debt burdens in China.

Why is inflation able to reduce the debt pressure?

Inflation works in the same way as compound interest. It creates asset appreciation and causes wealth accumulation much faster than debt because debt is not subjected to the same effect.  Therefore, inflation is able to reduce the debt pressure in China.

However, China cannot afford to sell all its US treasuries because overwhelming inflation will create an overheating economy and China has to manage the burgeoning inflation well or else it will have a bigger problem to resolve in the future.  Fortunately, the worldwide economic situation has created an ideal environment in China for inflation to rear its head.  Why?

The ECB has just stated its willingness to implement a QE policy with an interest rate cut recently.

https://www.economist.com/finance-and-economics/2019/06/18/donald-trump-takes-aim-at-mario-draghi-over-interest-rates

Furthermore, the US is also keen to reduce its own interest rates.  Financially speaking, the money will usually flow to a higher interest rate country (China) from a lower interest rate country (EU,US).  Thus, China doesn't need to do anything but to wait for the capital inflows from the EU and US when they reduce their interest rates.  In conclusion, China just needs to sell enough US treasuries to maintain a stable RMB and the expected capital inflows will work its wonders in China.

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