The Flitter Warning

Periodically, Reuters’ Emily Flitter files a story on the Sino-American financial relationship that contains great reporting.  Unfortunately, analysts and pundits often take that reporting and misinterpret what it means.  The hardworking staff at this blog hereby dubs this phenomenon The Flitter Warning. 

Her latest story, which got the Drudge link and was widely linked to, reveals that China no longer has to go through Wall Street to buy U.S. Treasuries:

China can now bypass Wall Street when buying U.S. government debt and go straight to the U.S. Treasury, in what is the Treasury’s first-ever direct relationship with a foreign government, according to documents viewed by Reuters.

The relationship means the People’s Bank of China buys U.S. debt using a different method than any other central bank in the world….

China, which holds $1.17 trillion in U.S. Treasuries, still buys some Treasuries through primary dealers, but since June 2011, that route hasn’t been necessary.

The documents viewed by Reuters show the U.S. Treasury Department has given the People’s Bank of China a direct computer link to its auction system, which the Chinese first used to buy two-year notes in late June 2011.

China can now participate in auctions without placing bids through primary dealers. If it wants to sell, however, it still has to go through the market.

The change was not announced publicly or in any message to primary dealers.

Now, this sounds like China is getting some kind of sweetheart deal, or at a minimum preferential treatment in its dealings with the U.S. Treasury, which ruffles the feathers of the easily ruffled.  The Blaze, for example, suggests:  "Considering the fact that China is America’s greatest creditor, as well as the fact that they are becoming increasingly antagonistic in cyber security attacks, maybe – just maybe – granting the Communist country a direct computer link to the treasury auction system isn’t the wisest decision."

A closer look at Flitter’s story, however, reveals a more nuanced picture.  First, China isn’t getting a direct discount by bypassing Wall Street.  As Flitter notes, "Primary dealers are not allowed to charge customers money to bid on their behalf at Treasury auctions, so China isn’t saving money by cutting out commission fees."  On the other hand, China is likely saving some money by keeping Wall Street a little more in the dark about its buying intentions (and thereby preventing traders from driving up the price of securities China intends to purchase). 

Second, and this is really important — Flitter fails to explain an important strategic reason why the United States might agree to this arrangement.  She proffers two possibilities.  First, that because this financial relationship is so politically sensitive, both sides have an incentive to keep the depths of it under wraps.  Second, U.S. Treasury officials want to make the Chinese purchasers of U.S. debt happy. 

I’d suggest a third — through this arrangement, U.S. officials now have better data on just how much debt China is purchasing.  For years, Beijing has tried to conceal the extent of its U.S. debt purchases by going through intermediaries in London and elsewhere (see this Setser and Pandey paper for more on the details).  Flitter notes in her story that "in 2009, when Treasury officials found China was using special deals with primary dealers to conceal its U.S. debt purchases, the Treasury changed a rule to outlaw those deals."

This arrangement seems like a win-win deal to me.  China, by bypassing Wall Street, saves a bit on its debt purchases by not moving the market so much.  The United States, by dealing with Beijing directly, gets more accurate information on just how much U.S. debt China is purchasing.  Flitter’s reportage, in other words, simply confirms the existence of mutual interdependence between China and the United States, not asymmetric dependence.  Which sounds… awfully familiar. 

So, let the Flitter Warning go forth — interesting new facts, but not much to worry about here.