The U.S. May Be The World’s First Re-Emerging Market

Remember how China was the hot emerging market not so long ago? Everybody with an almanac went on TV to tell us that “the story in China is people. Lots and lots of people.”

“So, you’re saying China has a big population?”

“Big? Not just big. The biggest! All those Chinese need cars and microwaves and razors for their legs and chins. Heh, heh, heh.”


Just after that world savvy analyst stepped from the cameras, another guest would appear to warn that China is “an emerging market. One with lots of promise, true, but a relatively unknown quantity. Its institutions just aren’t as safe as those in established countries.”

From the boob tube, you learned in that span of time that China has a big population but is an emerging market. This is typical of broadcast fare.

The big Chinese population angle is hardly worth paying attention to because the best way to tap it is by investing in companies that make the best products and/or offer the best services which, you’ll note, is the same way to invest regardless of how many people we’re talking about. The companies that will succeed in China are the same ones that succeeded in Germany, Japan, and the United States.

As for the danger of China as an emerging market, here’s an interesting twist: Chinese comprise one of the largest blocks of investors screwed by the Fannie/Freddie blow-up. China is the biggest foreign holder of debt issued by the two GSEs.

According to the U.S. Treasury, mainland Chinese investors owned $376 billion of agency long-term debt at the end of June 2007. That’s nearly 33% of total foreign holdings of the agencies.

Economist Brad Setser wrote last weekend:

China, according to the U.S. data, has $422 billion of long-term Agency bonds. That is roughly 10% of China’s GDP. It is also almost certainly understates China’s holdings. Based on the pattern of revisions in past surveys and the scale of China’s foreign asset growth, I would guess that China now holds between $500 and $600b of Agencies — or about 10% of the outstanding stock.

If — as I suspect is likely — the Agencies are too big, too important to the housing market and too Chinese for their debt ever not to be honored on time and in full, that has another implication:

China’s holdings of Agencies are effectively holdings of Treasuries, and China’s combined holdings of Treasuries total at least $924 billion. In reality, given the pattern of revisions and the scale of China’s reserve growth, its current holdings of Treasuries and Agencies now easily tops $1 trillion.

$1 trillion is roughly 25% of China’s GDP. That is a rather concentrated position. It shouldn’t be a surprise if China thinks it should have a voice shaping big U.S. policy choices.

In some sense, it is remarkable that the system for channeling the emerging world’s savings into the U.S. housing market — a system that relied on governments every step of the way, whether the state banks in China, that took in RMB deposits from Chinese savers and lent those funds to China’s central bank which then bought dollars and dollar-denominated Agency bonds, or the Agencies ability to use their implicit guarantee to turn U.S. mortgages into a fairly liquid reserve assets — hasn’t broken down after the “subprime” crisis. The expectation that the U.S. government would stand behind the Agencies is a big reason why.

That allowed the U.S. government to turn to the Agencies to backstop the mortgage market once the “private” market for securitized mortgages dried up, as emerging market governments continued to buy huge quantities of Agencies.

And it now seems that this game will break down on the U.S. end before it breaks on the emerging market end. The Agencies will run out of equity before central banks lose their willingness to buy Agency paper.

Tails are wagging dogs in all directions. The once emerging are now looking fully emerged, while the once emerged are looking submerged again. The U.S. may be the world’s first re-emerging market when it comes to finance.

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