Markets Conclude the U.S. Is Riskier Than China
(Bloomberg Opinion) -- Here's another reason Donald Trump is "not at all happy with the Fed" and will continue to be frustrated by the world's No. 2 economy. He is the first president to suffer the new normal of China becoming more creditworthy than the U.S. That's right: America now pays more to borrow money than China does.
Since 2015, when the Federal Reserve began raising interest rates, the gap between the countries' Treasury bills has narrowed and then reversed, so that now the U.S. must offer higher yields than China when it sells one-year paper. That happened for the first time in November, when the spread between Chinese and American 10-year notes also collapsed, according to data compiled by Bloomberg.
Only 45 basis points separates these two nations in the bond market. China still pays a little more on benchmark securities. But that historic advantage, which coincided with the embrace of the multilateral alliances that made America great and that Trump disdains, may disappear altogether as investors lose confidence in the full faith and credit of the U.S.
They would be pricing in various economic realities: the slowing rate of U.S. economic growth, the U.S. government's exploding debt, the diminished Treasury revenue caused by the 2017 tax cuts, and the Fed's pursuit of a monetary policy keeping rates well above their average for the decade.
Investors see growth slowing, and it shows. Extreme fluctuations in the stock and bond markets the past month reflect investor anxiety over the transition from a brightening economy to the creeping sense that the best of this cycle has come and gone.
U.S. government debt is also moving in the wrong direction. Since 2016, when the federal budget deficit as a percentage of gross domestic product declined to a decade-low of 2.2 percent from more than 10 percent in 2009, the deficit nearly doubled to almost 4 percent. GDP increased to a record $19.39 trillion at the end of 2017 as the annual rate climbed to 2.2 percent from 1.8 percent in 2007. But U.S. growth will deteriorate to an annualized 1.9 percent by 2020, according to economists surveyed by Bloomberg, putting more pressure on the widening deficit.
Revenue isn't stepping in to close that gap. The Trump tax cuts are estimated to increase these deficits by $1 trillion during the next 10 years.
The dichotomy between the U.S and China in the credit markets is exacerbated by the Fed's determination to return the economy to normalcy: It cut the federal funds target rate to zero during the financial crisis and raised it eight times since then to 2.25 percent. During the same period, China's benchmark one-year lending rate declined to 4.35 percent from 5.31 percent, according to data compiled by Bloomberg.
China isn't about to tighten credit appreciably while the economy shows no signs of accelerating. The nation's $12.24 trillion GDP is looking less robust after growth declined to 6.9 percent last year from 14.2 percent in 2007 and its deficit increased to 3.72 percent from a budget surplus a decade ago, according to data compiled by Bloomberg.
Even though China remains an emerging market, it shares some of the characteristics of Japan and the No. 3 economy's historically tempestuous relationship with the U.S. over trade. China recognizes that its export-driven model is peaking as it attempts to transition to a developed economy. Like Japan, it has the savings to soak up its own debt and supplanted Japan four years ago as the largest holder of U.S. Treasury securities, now totaling $1.15 trillion, according to data compiled by Bloomberg.
Because China and Japan have perennially large trade surpluses with the U.S., they use these excess dollars to buy Treasuries. China also manages its exchange rate by buying and selling dollars and yuan. Treasuries remain the primary vehicle for exchange rate management in such a predetermined band. The dollar depreciated 4.4 percent since the end of 2016, according to the Bloomberg Dollar Spot Index that tracks the performance of a basket of 10 leading currencies to the American currency. That's another way of making U.S. debt more expensive.
China and Japan, which account for more than $2 trillion of U.S. securities, have reduced their holdings in recent years. As the U.S. increasingly relies on the bond market to finance its budget deficits, reduced demand at a point when such deficits can only become more burdensome will force the U.S. to offer higher rates.
As much as he loathes the Fed for following its mandate to reach equilibrium, Trump must accept the additional indignity of being America's first president to pay higher yields than China to finance the U.S.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Matthew A. Winkler is a Bloomberg Opinion columnist. He is the editor-in-chief emeritus of Bloomberg News.
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