China is still the largest foreign holder of U.S. bonds. But it has pulled back over the past year. That could be a concern.
NEW YORK (CNNMoney) -- China is reportedly looking to step up its efforts to help Europe. But will this come at the expense of the United States?
China still holds a gargantuan amount of U.S. bonds -- $1.1 trillion as of December, according to the latest figures from the Treasury Department released Wednesday.
Still, that's down from $1.17 trillion in July and it is the lowest level in a year. But what's $70 billion or so among frenemies?
There are several reasons why China may be pulling back a bit. I'll get more into that shortly. But it's no secret that China isn't thrilled that the U.S. has yet to get its mounting debt and deficit problems under control.
It also can't be too pleased that all the bonds it holds are paying historically low yields, in part due to stimulative monetary policies that the Federal Reserve has had in place since the dawn of the financial crisis in 2008.
That could be a problem.
As much as we may hate to admit it, it is important for the U.S. to keep China happy. If China started selling even more of our debt, it could lead to a spike in interest rates -- and that's the last thing consumers need with the economic recovery still in its early stages.
One need look no further than Italy, Spain, Greece and Portugal for examples of the nightmare that can occur when nobody wants your sovereign debt and interest rates skyrocket.
I can almost picture President Obama singing the following tune to China Vice President Xi Jinping during Xi's White House visit yesterday -- on Valentine's Day no less. With apologies to Neil Diamond and Barbara Streisand:
You don't say you need me. You don't sing me love songs. You don't buy my bonds anymore.
The good news is that while China may be slowly paring back on its U.S. Treasury holdings, it is not unloading them in a rapid fashion.
One reason for that is that China is smart enough to realize that a sudden sale of Treasury debt would lower the value of its remaining holdings. That's not in China's economic self-interest.
"A modest move up in yields would be helpful for China's holdings. But they don't want a dramatic shift. That would hurt them," said Jim Barnes, senior fixed income portfolio manager at National Penn Investors Trust Company in Wyomissing, Pa.
There's also the issue of where China could put its money if it sold more Treasuries.
The size of the bond markets for most other countries with vibrant economies pales in comparison to the U.S. fixed income market.
"China is probably willing to sell more U.S. debt. But look at the alternatives. The debt markets in Brazil, India and South Africa are still too small," said Murillo Campello, professor of finance at Cornell University's Samuel Curtis Johnson Graduate School of Management.
As for Europe, Campello believes China isn't going to make more investments because it is more optimistic about the fiscal outlook for Greece. It will make investments because it has to.
The EU is China's largest trading partner. China may have to hold its nose and buy more European securities just to stem the bleeding. Campello said the key though will be for China to help out in a way without looking like it's making a sucker's bet.
"China understands they have to help Europe with its problems because at the end of the day they would be helping themselves," Campello said. "But they don't want to be perceived as the white knight."
So as long as China doesn't take a bold move to significantly raise its euro-denominated holdings and cut back on U.S. bonds, a continued, slow unwinding of Treasury debt won't create any major interest rate headaches.
In fact, Barnes thinks that China is just simply taking the wise move of spreading the wealth around. He does not believe China is protesting U.S. fiscal policy.
"China has said repeatedly it would like to diversify its assets and look for other opportunities," he said. "This is not a threat because it's not about the credit risk of the U.S. as much as it is about the risk in their portfolio."
It's also worth noting that China isn't the only game in town. Even as it is pulling back on Treasuries, other foreign nations are showing an increased willingness to lend to Uncle Sam. Japan and Brazil have boosted their debt holdings over the past year.
Best of StockTwits: Zynga (earnings report following its initial public offering. And Yahoo ( , Fortune 500) investors are still unhappy even after a board shakeup. Imagine that.) disappointed in its first
Ha! I still don't think tech overall is a bubble. But some of the social media companies like Zynga and Groupon ( )? That's a different story. The fundamentals don't justify the multi-billion dollar valuations. Even for Facebook.
I wonder if Loeb thinks his slate of board members can actually "fix" Yahoo or if he too would push for a sale. Honestly, Yahoo has some soul-searching to do. You can't be a turnaround story for a decade. A takeover may be the only way this story ends well for shareholders.
The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.
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