Sourcing an estimated 4 trillion yuan ($586bn) is no mean feat — even for China.
There are a few theories floating around. The prospect of China dumping a vast portfolio of Treasuries is one that has struck fear into the hearts of investors for some time now. It was being mentioned again yesterday:
‘For starters, China must of course finance its plan, which could mean it will have to either sell its holdings of U.S. Treasury and agency securities or slow its rate of accumulation in these securities,’ [Miller Tabak strategist Tony] Crescenzi wrote in a note… Massive selling of those securities, at a time when the U.S. government is already expected to issue large amounts of debt to finance its own economic stimulus measures, could further raise borrowing costs, such as mortgage rates, which are benchmarked to bond yields.
A flood of treasuries coming onto the market would have massive implications for US interest rates, as well as the Tarp, which is entirely dependent on demand for Treasury issuance.
Bank of America economists Lawrence Goodman and Christy Tan, for one, think China should be able to finance much of the package from its own pockets:
The authorities have run extremely small deficits over the last several years and government debt as a percent of GDP remains at around only 20%. So the authorities clearly have capacity and scope to expand the economy via fiscal stimulus. In fact, close to all of previous deficits have been financed internally with very little reliance on external markets hence public external debt is less than 1% of GDP. Even total external debt including private sector obligations is around a total of 10% of GDP.
All that is based on BoA’s estimates, of course, given China’s rather secretive public balance sheet:
Furthermore, the package may also already be partially accounted for in the 2008 budget, BoA, also says.
A portion of the outlined package appears to have been already incorporated into the 2008 budget… Some market estimates place the stimulus package as high as 16% of GDP. They appear to represent an overestimate with the programmed spending beginning in 4Q2008. The injection of stimulus from higher spending and revenue relief would likely reach about 11.2% of GDP phased in between 4Q 2008 and the end of 2010…
The overall public sector balance improved coincident with strong growth peaking in 2007, pushing the overall balance into a small surplus of 0.7% of GDP. A change in stance evident by a proscribed “pro-active” fiscal policy into 2008 represented a stark change from the prudent policy management outlined in 2005-07. Even with the recent expansion the overall deficit will likely fall far short of 1% of GDP in 2008. On balance, revenue growth is already slowing and expenditure growth is increasing. Assuming that CNY520 is part of the 2008 budgeted package and the remaining stimulus is evenly distributed in 2009 and 2010-fiscal injections would reach 5.1% and 4.5% of GDP, respectively.
Still, there’s a bit of a chicken and egg situation here. If the package doesn’t end up stimulating the economy as much as it’s supposed to the government’s ability to finance it will obviously be hampered. BoA now thinks GDP growth will slow to 8 per cent into early 2009, rather than the 6 per cent feared by some. Econbrowser, however, is even more downbeat:
What this suggests is the Chinese leadership sees a somewhat more pronounced slowdown in growth than the IMF. The IMF’s revised outlook released Thursday indicates a 0.1 ppt reduction in 2008 y/y growth, and 0.8 ppt reduction for 2009 y/y growth. These are revisions relative to those released less than a month ago. Current IMF projections (as of Thursday) are for 2008 q4/q4 of 9 ppt, and 2009 q4/q4 of 8.3 ppt.
Furthermore, would China’s own funding of the stimulus package unleash inflationary pressures at home? Peter Schiff, president of Euro Pacific Capital, argues it would. He says the Chinese simply can’t hoard trillions of USDs, buy new debt being issued by the US government and borrow or print their own stimulus funding without suffering dire inflationary consequences. As a result, it makes much more sense for the Chinese to sell-off their treasury reserves.
Selling down their vast reserve of U.S. debt in order to spend on domestic infrastructure (or anything else for that matter) is vastly superior to ‘lending’ it to Americans. If the Chinese authorities finally figure this out, the United States will suffer the consequences.
Bad news for the Tarp then.
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