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A Chinese view of sovereign credit risk & solvency

The Dagong Global Credit Rating Co. Ltd. is a credit rating and risk analysis research institution founded in 1994 upon the joint approval of People‘s Bank of China and the former State Economic & Trade Commission,  People’s Republic of China. Think of it as an informational and policy utility.

They have published their 2011 Sovereign Credit Risk Outlook which contains important perspectives, that is if one chooses to listen to one's investor base. It's an interesting document in it's own right, and highlights with some liberties follow:

Review of 2010

  1. The credit quality and in some cases solvency of key developed debtor countries declined sharply
  2. They accuse the United States, "the world's largest debtor country" of waging "global credit warfare"presumably by excessive monetary expansion (printing money) and excessive debt issuance. One infers that they appropriately fear a declining US$, a rising Yuan, and an inflationary collapse of the US bond prices, in essence a devaluing of their holdings.
  3. The credit risk of developed debtor countries damaged the world economy and growth prospects

Outlook for 2011

  1. The financing needs of the developed debtor countries will continue to rise
  2. Developed debtor countries will be constrained by macroeconomic factors resulting in no improvement in their credit quality
  3. No fundamental changes have occurred, so sovereign debt crisis in the euro zone countries will get worse
  4. The United States will continue its quantitative easing policy and the world "credit war"will be escalated by excess money and unsustainable growth of US debt
  5. The credit risks of the developed debtor countries continue to impair global growth

We presume that Dagong, the Chinese Central Bank, and the government were in agreement regarding the publication of the document, and take it to be party line or at least the first phase of it. They run a very large book of US Treasuries, so they are a party at interest.

The Chinese concern is simple: they don't want their holdings devalued by currency weakness or inflation.  It is a concern any holder of US financial assets, including clients of WWB, shares. The English prose of the Chinese is direct and clear, at least clear enough relative to Tim Geithner's jargon when talking about quantitative easing or Turbo Tax.  It seems Bill Gross agrees with them too. As we pointed out in a prior posting, he very publicly dumped all the Treasury bonds out of the Pimco Total Return Fund, the largest US$ bond fund in the world. He's the home team, and notwithstanding the size of his book he had more tactical flexibility than the Chinese, a seat closer to the door, if you will. 

Perhaps the Fed, Congress, and the Obama administration ought listen a bit? We confess we're not holding our breath. We do tend to take the Chinese central bank seriously, and while we recognize they have less tactical flexibility than Mr. Gross, we're not sure its prudent to bet on that constraint. They'll have it priced to the penny. 

Our loyal readers have long known our thoughts on inflation risk, and to anyone sitting on any bond duration, may we suggest a seat near the door, too?  It might get crowded very quickly as in chaotic non-linear responses of dynamic systems.

Oh, and did we mention Alan Greenspan in the Financial Times today?

"Alan Greenspan, the former Federal Reserve chairman has attached th Dodd-Frank financial reforms, warning they could create the 'largest regulatory induced market distortion" in the US since the imposition of wage and price controls in 1971'..."

One can't help but get the growing sense that confidence in the US capital markets and their efficiency is also seated near the door. A paucity of IPO's. The NYSE bought by the Germans for packing & shipment to the Netherlands of wooden shoes, tulips, and gouda cheese?

We are not assured by quality of our political leadership, it's understanding of wealth creation, or the state of our regulatory acumen in any discipline.

Gold anyone? Non-nano etched diamonds?

Reader Comments (2)

China can't leave no matter how much they want to? Where do they go when they go out the door? Japan? Euroland? Into RMB? If the CCB does that, Chinese exporters will be crushed. 10% GDP growth is pretty much all that is standing between the CCP and oblivion.

Oh and did I mention that Alan Greenspan is an ideology-driven fraud whose policy errors were primarily responsible for the US's lousy credit quality now so many years after his unlamented departure?
April 4, 2011 | Unregistered CommenterDrew
I agree that China has, at least for now, limited options. Euroland and the emerging markets may provide some magnitude of alternatives in the coming half decade or so. One suspects their credit quality will improve relative to the US and certainly they'll have bonds to sell in abundance. China may be trapped here for a bit, but meanwhile they have the ability to manipulate the volatility and absolute level of either side of the US Treasury market...not good for the bond boys or geopolitical strategy.

Unfortunately, citizens of the US are trapped right along with China and holding the same bag or catching the same falling knife. Most can't get out of the US$ or US fixed income exposure. If your thesis is that long US$ duration is a good buy, well, good luck to you.

We'll leave Frank Dodd for another day: it's a mess.
April 5, 2011 | Registered Commenterhb

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