China felt betrayed when the American government allowed Lehman and Washington Mutual to fail
Apparently, for the last several years, China has been assuming that the American government would stand behind the major corporations of the American financial sector. Those Chinese officials who were handling China’s foreign investment portfolio were shocked that the American government would allow companies such as Lehman Brothers and Washington Mutual to fail. Apparently these officials are now suffering political consequences for having lost so much money. This is from Brad Sester’s blog:
It seems like China’s top leaders knew less about China’s portfolio that American reserve watchers; it is not inconceivable (gulp) that I was the source for those published report about China’s Agency holdings. My own work with Arpana Pandey, incidentally, suggests that China’s holdings of Agencies were closer to $600 billion at their peak – though it is possible that China never held more than $400 billion of Fannie and Freddie debt, as there are other kinds of Agency bonds.
The Journal’s story also confirms that there has been a huge swing in the management of China’s reserves. The TIC data, which has shown a huge increase in China’s Treasury holdings, wasn’t off.
It turns out that one of China’s main criticism of US policy is simple: the government didn’t stand by institutions that China expected the US to support. Lehman. Wamu. And the Reserve Primary Fund. Dean, Areddy and Ng:
“Leaders in China, the world’s third-largest economy, have been surprised and upset over how much the problems of the U.S. financial sector have hurt China’s holdings. In response, Beijing is re-examining its U.S. investments, say people familiar with the government’s thinking. …Chinese leaders have felt burned by a series of bad experiences with U.S. investments they had believed were safe, say people familiar with their thinking, including holdings in Morgan Stanley, the collapsed Reserve Primary Fund and mortgage giants Fannie Mae and Freddie Mac.”
And yet, despite all this, China still feels they can not sell their American assets. The American dollar’s exchange rate remains strong. China knows that it will lose a lot more money on its American investments, yet they seem helpless to do anything about it.
From the American point of view, the ideal outcome would be that China sells some of its American assets, which causes the American dollar to come down a bit, which makes American manufacturing more competitive overseas, which would allow a boom in American exports, which would pull America out of its depression. And yet, this is the outcome that China fears most, so apparently it is willing to stoically lose more money in America, rather than allow the American dollar to weaken.