What If China Sells All Their US Treasuries?

Third and final post of a 3-part series. Read part 1 here and part 2 here. As a follow-up to this week’s mailbag question of whether China is buying up US real estate and debt, there is often an underlying fear (perpetuated by politicians running for office) that China has leverage over the US, because they can sell all of their US debt.

If China sells their US debt, they will have a lot of US Dollars (USD). Theoretically, I suppose they could just hold straight USD, but this is unlikely for a variety of reasons so let’s look at their realistic options:

  1. China could repatriate the cash, by exchanging USD for renminbi (RMB). But this would effectively be selling USD to buy RMB and would cause the USD to depreciate and the RMB to appreciate. If you’re​ an export-centric economy, why would you want your currency to appreciate against your main trading partner’s?
  2. China could exchange USD for other currencies, such as Euros (EUR), Yen (JPY), or Pounds (GBP). This would cause the USD to depreciate and those other currencies to appreciate. This is not an ideal outcome either though, since it would also drive the USD lower and the US is China’s largest trading partner. Presumably, the EUR, JPY, and GBP would strengthen and exports to those countries would do better though. However, I don’t see why these countries would buy USD just because China did not want it, especially if they had to increase their own money supply or buy more stuff from the US.

As you can see, China does not have a lot of options. Just as they’re more or less forced to buy US debt, they’re more or less forced to hold it. So the next time a politician starts warning about China owning and selling US debt, call BS!

Reader Mailbag: Are the Chinese Buying All of Our Debt?

Part 2 of 3 part series. Find part 1 here.

Today we’ll be looking at the second part of Matthew W’s question: Is China really buying up all our houses and debt and does it matter?

No, the Chinese do not buy all of our debt, but they do buy a lot of it. The below chart is a few years old, but I like how it illustrates the data and the percentages have not changed drastically (although Japan now holds slightly more US debt than China).

Before getting into the implications, let’s look at why China buys US debt. 

The US buys a lot of stuff from China. A lot. Like the most stuff one country has ever bought from another. 

When someone in the US buys something from someone in China, the American buyer sends US Dollars (USD) to the Chinese seller. The Chinese seller now has USD, which is not very useful in China. So the Chinese seller exchanges his USD for renminbi (RMB), with the government. Now, the government has a bunch of USD.

The Chinese government has trillions of USD, so they have a lot left over even after spending and investing hundreds of billions of it. Rather than holding over a trillion in cash, they buy US Treasuries, AKA US debt. There’s little else that you can do when you have that much cash. This, China is more or less forced to own a lot of US debt due to the trade surplus that they have with the US.

Every election cycle includes politicians railing against the fact that we’re indebted to China and they control us. But let’s look beyond the rhetoric and see if China’s lending to us matters at all, much less in a negative way. A few important points: 

  1. There’s an old joke that if you owe the bank hundreds, that’s your problem. If you owe the bank millions, that’s their problem. In all seriousness, this is sovereign debt, not collateralized by anything. China does not have a claim on US assets or the right to repossess anything.
  2. US debt is owed in a currency that the US can print at will. Domestic politics may create situations where the US does not have the willingness to pay (a la the debt ceiling debacles in Congress), but it will always have the ability to pay.
  3. Given the above, having a large trade deficit where China holds our debt does not seem like a bad situation. We buy actual, physical goods with money…that we print. And they’re forced to buy our debt with it. We send paper and electronic currency and we get real things back.
  4. Lastly, the marginal demand for debt from China probably keeps US rates lower than they’d be otherwise. 

The next and final post of this series will look at the question of whether China can or will sell their US debt and the possible implications. Stay tuned.

Reader Mailbag: Is China Buying All of Our Houses?

Question from Matthew W: Is China really buying up all our houses and debt and does it matter?

It is a common question and I’m going to break the answer into two posts, one on real estate and one on debt. Below are my thoughts on the the real estate part of the question:

The short answer is yes, a lot of US real estate is being bought by Chinese investors. See herehere, and here for details.

On to the second half of the question: does it matter? Whether it matters or not depends on where you sit and what you care about, but it certainly has an impact.

Houses and buildings take time to develop and build. Unlike stock or bonds, buildings cannot just be printed to meet increased demand. When there is increased demand for a limited supply, prices increase. It is impossible to know how much of the recent real estate price rally is attributable to Chinese buyers, but it is certainly a factor. So I would say, yes, Chinese are buying a lot of US real estate and it’s contributing to price appreciation.

Perhaps implied in the question is a fear that “the Chinese are taking over” by buying up US property, from trophy assets in “A markets” to residential homes. The same fears existed in the 1980s, except people were afraid of the Japanese. In that episode, Japanese investors bought at extremely high valuations and often lost money when the cycle turned. The future may not unfold like the past, but I am not too concerned about Chinese property purchases at this point.

Crowdsourcing Questions

Last week I asked my fb network for financial questions or topics that they’d like to see addressed on this blog. Not only was I surprised by the number of responses that I received both publicly and privately, but also the breadth of topics. Everything from common retirement questions to questions about financial products and macroeconomics. I’m looking forward to writing about and discussing these topics, along with the investment ideas that I typically write about.

If you have a question or topic that you’d like addressed, leave a comment or send a message using the contact button!

Fear & Greed

A classic from Carl Richards, at Behavior Gap. I see it everyday on my office wall, but I still like to post it from time to time.

Defining Alternative Investments

At a recent conference, I was reminded that definitions in the “alternative investment” space can be ambiguous and sponsors/managers are more than willing to slap the “alternative” label on nearly any investment product for marketing purposes.

One of the most helpful lessons I learned about “alternative” investments was that there is no such thing as an alternative asset. Every investable asset is either equity or debt. Let’s look at some common assets:

Stocks = equity in a company
Bonds = debt owed by a company
Real Estate = equity in a land or building
Mortgages = debt owed by a real estate owner
Commodities = equity in a physical asset

*Derivatives could technically be classified as a third category, but they will “derive” their value from equity or debt and can behave like either depending on the structure.

So the most important thing to know about alternative investments is that there’s no such thing. “Alternative” describes an asset’s place in a classification system, but not an inherent attribute. Hybrid assets, structured products, hedge funds, private equities, infrastructure, and so on can all be disaggregated into equity and debt. So before investing in an “alternative” investment, throw out the alternative moniker and understand what exactly the investment is and how it will behave. This simplified framework has been invaluable to me and I hope it is for you too!

GiveWell Panel

Earlier this week, I attended a panel discussion at GiveWell that focused on issues surrounding the Randomized Control Trial (RCT) movement within the non-profit/NGO sector, which is fancy way of saying that organizations should have some evidence that their programs work before trying to scale them up.

Before I share my notes, let me share some context. Like many other fields, there is a greater demand and push for data-driven and evidence-based solutions. Clearly not everything can be measured and there is room for experimentation and unproven ventures, yet there are a lot of organizations that cannot reliably prove that they have much (if any) impact relative to the status quo counterfactual.

An implicit premise of the discussion was that a lot of RCT data is dirty and results from similar trials can be highly variable. This is not surprising, since much of this data is from impoverished locales.

There was some debate over the bias towards studies that illustrate globally consistent conclusions vs  recognizing that geo-specific differences can and do exist. There was also a debate over bottom-up grassroots work vs top-down public policy solutions.

Even in charitable, intervention, and development programs, there are no sure bets. Having a 95% confidence level in what you’re doing is unrealistic (95% falls within two standard deviations and is often accepted as a sure thing). Even 80% confidence levels may be too high a bar. Panelists agreed that there is no hard and fast threshold for supporting a program, but confidence levels, cost, practical considerations, and externalities should be considered.

Below are several other comments that I found interesting:

  • It is difficult, if not impossible, to separate a program’s effectiveness from the organization running it. 
  • Data collection could be a lot better because much of it is driven by academics who have different incentives that decision-makers and practitioners.
  • A case can be made to support a less organized organization with poor data monitoring rather than an organization with great data, if the there’s a wide disparity in the estimated impact (ie. deworming programs can increase incomes more than cash transfer programs by a factor of 10x)
  • Some of the biggest surprises the panelists have seen has been behavioral incentives having outsized positive impact (ie. immunization rates shooting up dramatically if you offer a kilo of lentils)

Overall, I enjoyed the event. Rather than an overconfidence in RCTs and data, the panelists were upfront about the limitations and misuses of RCT data. This surprised me since GiveWell has built their reputation on data-driven giving. To some extent, philanthropy is like anything else: you make decisions about an uncertain future with incomplete and imperfect information.

LA Trip: Elevated Valuations

Just back from a conference and meetings in LA and a recurring theme I heard was that valuations appear high. I heard this regarding both public equities and private equity, rates and credit, as well as real estate. The common refrain was, “Opportunities are scarce and extra caution is warranted.”

The implications of high valuations are different for equity and debt investors, however both face the following challenges:

  1. The first problem with high valuations is that carry (current cash flow from owning an asset) is low. Valuations are often expressed as a ratio or multiple of some cash flow, so high valuations are synonymous with low earnings yields, credit spreads, cap rates, and so on. While prices can always decline, higher carry helps mitigate that risk. Conversely, very low carry leaves much less room for error and may not be sufficient.
  2. A second problem with high valuations is that they can decline (duh!). If valuation metrics are mean reverting and they are on the higher side, then they will likely decline at some point. The question is whether valuations decline from improving fundamentals or declining prices.

Again, valuations have differing implications for various asset classes, but exercising extra caution in expensive markets is rarely a bad idea.

A Dozen Things I Learned in Cuba

“We don’t go on vacations. We go on your field trips.”  -my wife, pictured above in Habana Vieja

[a repost from FB, based on the positive feedback I received and the fact that many of the below points are economic in nature]

I’m going to channel my inner Tren Griffin and share 12 things that I learned in Cuba, based both on my observations and on the handful of conversations that exceeded 15-30 minutes. A small sample size and subjective, so take it for what it’s worth. However, I tried to ask different people many of the same questions for corroboration and to understand the nuances and variety of perspectives.

1. Almost everyone works for the government and earns $20-40 per month, which is not enough to cover basic needs in Cuba. I start with this fact because it has many implications and helps explain many of the following points.

2. Many people steal from their jobs to survive. If you buy 4 cups of rice, you’ll only get 3 cups. If you buy a bottle of cooking oil, it will only be partially full. Everyone accepts this. The missing amounts are sold by employees to supplement their meager incomes. Other people operate side businesses by reselling the stolen goods or black market goods brought in on commercial flights (like Colgate toothpaste, which is much better than what can be found in stores).

3. The government provides free education and medical care. The general consensus seems to be that it was decent until the USSR (and it’s subsidies) collapsed. The quality of education and medicine is pretty low and one person said that teachers and doctors will provide mediocre service unless paid under the table.

4. Service is generally slow and terrible/non-existent. Since the government runs nearly everything, there is very little competition or profit-incentive, and everyone gets paid the same regardless of skill or effort. Many Cubans lamented how lazy this makes the majority of employees. Service at private businesses is markedly better, to the point that you can pretty easily distinguish a government-run business from a privately-run one based solely on quality of service.

5. There is a serious lack of resources. People complain that they cannot find the basic things that they need. They may spend a few hours per day visiting multiple stores before being able to find basic staples like rice or oil. Most stores I saw just had empty shelves. Even as a tourist eating at the most expensive restaurants, many menu items were often unavailable (a couple of times there were only one or two dishes available, out of a menu of 10-20 items). We had a couple great meals, but the food quality was pretty low overall.

6. American tourists are flooding the island. Flights from the US started just a few months ago, but it’s already bringing an unprecedented number of tourists. People shared that they have never seen the numbers of visitors that they’ve seen in the past few months. There is a consensus that US tourism will be massive, but there also seems to be a lot of fear of what changes it will bring. While tourism is booming, so is food and rent inflation. The business owners I spoke to said business is better than ever and exceeding all expectations. Yet, they also shared that Cubans are getting priced out of housing, goods, and services.

7. People do not keep their money in banks. For one thing, Cubans are worried the government may confiscate or revalue the currency (which is roughly pegged to USD). Technically, it’s only legal to exchange currencies at official exchanges, but many Cubans will offer better rates for hard currencies on the black market so they can accumulate currency that will hold its value better (both the exchanging and owning of foreign currencies is illegal for Cubans). Secondly, bank tellers will ask for the source of any deposits. Since the majority of people’s income is from black market activity, they cannot deposit funds in the bank.

8. Wealth is not flaunted. In fact, it’s deliberately hidden. If a Cuban took multiple day trips or overnight trips around the country (like we did), the government may knock on your door, interrogate you and investigate the source of your money. Even licensed private business owners keep a very low profile. All expressed a fear that success would bring attention and that the government would shut down their business. Many people mentioned that they are starting make more money, but they cannot enjoy it at all for fear of bringing attention to themselves.

9. Despite the progress, people are not as optimistic or confident as I expected. Everyone I spoke to mentioned that although things are improving lately, the government can roll all the reforms back in an instant. They’ve done it before and they may do it again.

10. Despite the party line, there is an economic hierarchy and racial issues. I spoke to someone that said they didn’t like black people. I spoke to a black person who said he’s been discriminated against.

11. A couple people mentioned the old, fat men that come to Cuba for young girls. Both mentioned an hour costs $20, which I took to mean that it’s common enough that the average person knows the standard price. One person pointed out a schoolgirl walking by and said “She’s looking for men.” The girl looked like normal adolescent kid in a school uniform and I asked how they could be sure. “Do you want me to prove it?” my acquaintance replied. I passed.

12. There is clearly a wealth gap between Cubans and foreigners, but nobody tried to guilt us or ask for money. We did pay foreigner premiums and people took commissions for helping us arrange things, but we only ran into one insistent tout/jintero and two people asked me for food. We did see many street performers attempting to earn money. Cubans are proud and not looking for any handouts, IMO.

People were very friendly and happy to chat. I feel fortunate to have visited and met so many people. Although I probably won’t visit again, I had a good time and learned a lot.  Viva Cuba!

Let’s Try This Again

I’m going to try re-launching this blog with an expanded focus. Actually, it’s more of a consolidation than an expansion because while I’ve focused on finance and investing topics here, I started writing about global and justice issues over at mattshibata.com and post other random thoughts and analysis to FB. I’ll leave the photos and banter at FB, but centralize all other writing here for convenience sake.

Most of my writing relates to finance or economics in some way, so I expect this blog will continue be finance-focused. However, finance will be a thread that’s woven into many posts rather than the sole focal point. Rather than writing about financial topics in isolation, they will be within a much larger context. We’ll see how this goes.