Bel­gium now a ma­jor holder of U.S. bonds

The Washington Times Weekly - - Geopolitics - BY PA­TRICE HILL

Call it the Great Fi­nan­cial Mys­tery of 2014.

The small Euro­pean coun­try of Bel­gium this year sud­denly be­came the world’s third-largest for­eign holder of U.S. Trea­sury bonds — putting it be­hind only fi­nan­cial gi­ants Ja­pan and China.

The de­vel­op­ment has set Wall Street abuzz and in­spired a raft of con­spir­acy the­o­ries among traders and an­a­lysts to ex­plain what’s go­ing on. Some say the Bel­gian buy­ing spree is the work of wor­ried Euro­pean of­fi­cials try­ing to pre­vent the Federal Re­serve’s grad­ual tight­en­ing of in­ter­est rates from driv­ing up rates in Europe. Oth­ers say it’s a sub­ter­ranean ef­fort by China to prop up the U.S. dol­lar and aid its ail­ing econ­omy.

The mys­tery was spawned by a doubling of Trea­sury pur­chases em­a­nat­ing out of Brussels since Au­gust, which left the Bel­gian cap­i­tal with an ac­cu­mu­lated stash of Trea­sury bonds worth nearly $400 bil­lion — more than dou­ble the amount it held through most of last year. The ex­tra buy­ing is equal to half of the coun­try’s yearly GDP, or $20,000 for each of the coun­try’s 11.1 mil­lion cit­i­zens.

The Brussels-based clear­ing­house Euro­clear has ad­mit­ted that its clients — which in­clude more than 90 coun­tries and 2,000 fi­nan­cial in­sti­tu­tions — were re­spon­si­ble for the pur­chases but would not say which clients were in­volved.

The cloak of anonymity pro­vided by Euro­clear set off whis­pers and spec­u­la­tion on Wall Street about why the sur­rep­ti­tious bond buyer or buy­ers are try­ing to avoid iden­ti­fi­ca­tion. Per­haps the most nat­u­ral sus­pect that came to the fore was Bei­jing, which for years in­vested its mas­sive $4 tril­lion for­eign ex­change sur­plus in Trea­sury bonds to drive up the value of the dol­lar and en­sure Chi­nese ex­ports re­mained cheap for its mil­lions of Amer­i­can cus­tomers.

“China is al­most cer­tainly dis­guis­ing its Trea­sury pur­chases by hold­ing them in Bel­gium,” said Benn Steil, an­a­lyst at the Coun­cil on For­eign Re­la­tions, who noted that China has bought U.S. bonds on the sly be­fore through other off­shore fi­nan­cial cen­ters. By hid­ing its pur­chases, the Asian gi­ant is try­ing to avoid set­ting off an­other firestorm of crit­i­cism on Capi­tol Hill that it was ma­nip­u­lat­ing its cur­rency, he said.

China’s prac­tice of us­ing its dol­lar earn­ings from the sale of ex­ports to the United States to pur­chase Trea­sury bonds dur­ing the 2000s prompted wide­spread crit­i­cism from leg­is­la­tors and both the Bush and Obama ad­min­is­tra­tions. They blamed China for us­ing the tech­nique to main­tain a com­pet­i­tive edge in trade that led to lopsided trade sur­pluses with the U.S. More­over, the bond hoard­ing was blamed for help­ing to cre­ate the credit bub­ble that caused the hous­ing cri­sis and Great Re­ces­sion of 2007-2009.

The outcry in the last decade forced of­fi­cials in Bei­jing to pare back the prac­tice for sev­eral years. China’s sus­pen­sion of heavy bond buy­ing since 2009, as ex­pected, caused the dol­lar to fall and sparked a strength­en­ing of the Chi­nese cur­rency to record high lev­els, prompt­ing even some of China’s fiercest crit­ics to say last year that the trade and fi­nan­cial im­bal­ances caused by China’s cur­rency ma­nip­u­la­tion had come to an end.

But the change also helped cause a dra­matic slow­ing in China’s econ­omy, and this year, a por­tion of China’s cur­rency gains sud­denly dis­ap­peared as a re­sult. China in­sists that it is not re­sort­ing to old tricks and try­ing to ar­ti­fi­cially gin up the dol­lar and ex­ports to boost growth. But ob­servers note that its ex­ports and trade sur­plus are bal­loon­ing once again, and the Trea­sury Depart­ment this spring warned that it is watch­ing closely to see if China is back­track­ing on its prom­ise of re­form.

Sift­ing the ev­i­dence

Mr. Steil said the ev­i­dence is com­pelling that China has re­sumed its pur­chases of Trea­sury se­cu­ri­ties to en­gi­neer a de­cline of more than 3 per­cent in the Chi­nese yuan against the dol­lar this year, a move that as­sists Chi­nese ex­porters in their bat­tle to main­tain mar­ket share in the U.S and other global mar­kets. But be­cause of the po­lit­i­cal pres­sure in the U.S., China felt it had to act in se­cret.

“China’s cen­tral bank holds the key,” he said.

While China’s for­eign ex­change re­serves are surg­ing again, and be­cause in the past the People’s Bank of China in­vested about 40 per­cent of those re­serves in U.S. Trea­surys, re­ports show that China’s of­fi­cial, pub­licly known hold­ings of Trea­surys are in de­cline — some­thing that just doesn’t add up, he said. The bank must be sur­rep­ti­tiously in­vest­ing the sur­plus re­serves through the Bel­gium clear­ing­house, he said.

In one telling sign, China’s bond buy­ing, as in the past, is hav­ing a sub­stan­tial im­pact on U.S. fi­nan­cial mar­kets, Mr. Steil said. He pointed out that the com­bined im­pact of Chi­nese and Bel­gian pur­chases of $59 bil­lion of Trea­surys in Jan­uary alone was so mas­sive that it could fully ac­count for a mys­te­ri­ous de­cline in yields on 10-year Trea­sury bonds that month to 2.64 per­cent from 3.03 per­cent. The de­cline in in­ter­est rates was all the more puz­zling be­cause it came at the same time the Federal Re­serve started to pare back its own mas­sive pur­chases of Trea­sury bonds — a “ta­per­ing” that other­wise would have raised rates.

Be­yond the un­mis­tak­able signs of Chi­nese in­ter­ven­tion in fi­nan­cial mar­kets, he said, “China’s ac­tions would help ex­plain why Bel­gium, a coun­try whose [econ­omy] is slightly smaller than that of New Jersey’s, has be­come the world’s third-largest holder of Trea­surys,” he said.

Other sus­pects

But while some mar­ket gu­rus are con­fi­dent that the cul­prit is China, there are al­ter­na­tive the­o­ries about the se­cret bond buyer that also would ac­count for the enig­matic and un­ex­pected drop in U.S. in­ter­est rates this year. Un­der one prom­i­nent the­ory, the cul­prit is Europe.

“One of the big­gest ques­tions at the end of 2013 was how the Trea­sury mar­ket would re­act to the re­duc­tion of bond buy­ing that would re­sult from the Federal Re­serve’s ta­per­ing cam­paign,” said Peter Schiff, chief ex­ec­u­tive of Euro Pa­cific Cap­i­tal. “With­out the Fed’s bid, in­ter­est rates would have to rise.”

But six months into the cam­paign, with the Fed hav­ing cut its pur­chases by more than half, U.S. in­ter­est rates have ac­tu­ally fallen by a half point, he noted. It was that un­ex­pected phe­nom­e­non that led Mr. Schiff to scru­ti­nize the sud­den and mys­te­ri­ous frenzy of bond buy­ing from Bel­gium.

“The Bel­gian head-scratcher may be a sim­ple case of cen­tral bank quid pro quo,” he said, not­ing that the Fed aided the Euro­pean Cen­tral Bank in bail­ing out Euro­pean banks dur­ing the Euro­pean debt cri­sis, and now it looks like it may be get­ting a fa­vor in re­turn. For­mer Texas Repub­li­can Rep. Ron Paul, a mon­e­tary pol­icy maven, also sus­pects a link be­tween the two, he said.

“What is clear is that this is not likely the govern­ment of Bel­gium, or pri­vate Bel­gian cap­i­tal, that is do­ing the buy­ing. The num­bers are just too large,” Mr. Schiff said. “The only Euro­pean buyer with a wal­let that big would be the Euro­pean Cen­tral Bank.”

Mr. Schiff reck­ons that the Euro­pean bank, which has openly dis­cussed buy­ing bonds to aid the ail­ing Euro­pean econ­omy, moved to pur­chase Trea­sury bonds just as the Fed was with­draw­ing from the mar­ket to ease the way for the Fed’s tight­en­ing and thus pre­vent­ing a sud­den uptick in in­ter­est rates, which would have roiled fi­nan­cial mar­kets in the U.S. and Europe.

“Any panic in the bond mar­ket would cause yields to spike, which would have a strong neg­a­tive ef­fect on stock prices and eco­nomic con­fi­dence” — some­thing both the U.S. and Euro­pean cen­tral banks wanted to avoid, he said.

“It may not be co­in­ci­den­tal that the Bel­gian buy­ing be­gan in earnest just as the ta­per­ing got un­der­way. Some­thing may in fact be rot­ten, and it’s not in Den­mark … but sev­eral hun­dred kilo­me­ters to the south­west,” he said.

Mar­ket im­pact

A big part of the tan­ta­liz­ing mys­tery for in­vest­ment ex­perts is the dra­matic ef­fect the bond buy­ing seems to be hav­ing on fi­nan­cial mar­kets. Not only have U.S. in­ter­est rates stayed un­ex­pect­edly low de­spite the Fed’s tight­en­ing cam­paign, but the U.S. stock mar­ket has con­tin­ued its bull run, with the Stan­dard & Poor’s 500 in­dex re­cently hit­ting an­other record high.

In­vest­ment an­a­lysts note that it is highly un­usual to have such a strong rally in both stocks and bonds at the same time. The stock mar­ket tra­di­tion­ally ral­lies when the econ­omy is do­ing well and growth is strong, while the bond mar­ket usu­ally ral­lies when the econ­omy is do­ing poorly and growth rates are fall­ing.

Tom Por­celli, chief U.S. econ­o­mist at RBC Cap­i­tal Mar­kets, has spent much of the year try­ing to solve the puzzle and has closely scru­ti­nized the surge of Trea­sury bond buy­ing by mys­te­ri­ous un­known par­ties.

“The ques­tion is, who is the big buyer?” he said. Mar­ket sa­vants have pos­tu­lated it could be any­thing from pen­sion funds buy­ing up long-term bonds to bal­ance their portfolios to banks snap­ping up Trea­surys to ful­fill higher re­serve re­quire­ments laid down by reg­u­la­tors. Some spec­u­late that it’s not so much that in­sti­tu­tions want to buy more bonds but that the Trea­sury has fewer bonds to sell as the federal budget deficit continues its dra­matic de­cline, cre­at­ing a short­age of sup­ply, he said.

“And then there is Europe,” he mused, re­fer­ring to the­o­ries that Euro­pean bankers want to blunt the rise in in­ter­est rates be­ing en­gi­neered by the Fed.

But Mr. Por­celli dis­misses pretty much all such the­o­ries. His own pet an­swer is that traders them­selves have caused the un­usual surge in de­mand for Trea­surys and the fall in in­ter­est rates through var­i­ous ma­neu­vers in re­sponse to the Fed’s change of di­rec­tion this year. He ex­pects in­ter­est rates to re­sume their his­toric pat­tern of ris­ing later this year, when all the trader po­si­tion­ing and ma­neu­ver­ing has been “fully flushed out” of the mar­ket.

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