...Why would China need to sell bonds in a depressed market? One of the reasons they buy bonds is to keep the RMB at a low exchange rate relative to the dollar. Selling bonds would defeat that purpose, causing the RMB (yuan) to rise. Second, bonds pay a fixed interest twice a year. ...
They would sell for same reason anyone sells and takes a loss - the expectation that the loss will be greater later if they do not. Now with Treasury bonds and China it is more complex. To sell a bond, at a loss rather than hold to maturity, you must also expect the dollar to decline so much that the face value plus the interest received between now and maturity will not compensate for the lower purchasing power of the dollars given at maturity. (This of course is postulating that the bond issuer will not default, but that is nearly as certain as the sun rising in the US case, so long as the FED and treasury combo can "print dollars.")
Then, as you note, China does not want the RMB to rise in value so long as exports are a major part of GDP or more importantly, employ many Chinese. China is now realizing that even an undervalued Yuan, does not guarantee export markets if they people of those markets are broke. So the CCP is doing everything it can to stimulate less saving and more spending by its population, and more creative / innovative "garage based" industries by its new crop of university graduates. (Like in the US, many now graduating are having trouble finding a job, but China's banks, flush with cash, are giving them modest loans, almost or entirely interest free, to start their own business. Many will make new computer games etc. - a very big industry in China, with exports. I do not play any but understand some chinese even live by
playing these games. You can learn tricks built into the games that they then sell to others!)
Thus far, in 2009, holding US bonds, even considering the interest gained (or accumulated in the price, if not yet paid) has cost you 3.9% of the capital and slightly more in terms of the purchasing power. See kmguru's just posted graphs but the 3.9% comes from my post of Bloomberg text. Also if one averages over more than a year, for several years now bonds have been a way to lose money and surely the Chinese know this too. Thus I think one is forced to conclude that China has decided to accept this modest rate of loss in purchasing power to keep "re-cycling dollars" to American, but realized that switching to bills rather than bonds for all new purchases of Treasuries will reduce the loss rate. (As you surely know, shorter maturities are less damaged by interest rate rises. - Many others, also with fear of bonds, are doing this so yield curve is growing steeper every week now. (I am a more extreme case but always see far ahead. - I sold all stock funds in my retirement plans and bought TIPs, starting about 2.5 years ago in monthly dollar cost averaging that ended ~1.5 years ago. I missed a little of the market rise at the start of switching but all of them more important fall at end of 2008.)
...China knows they are at the mercy of the suppliers if they don't have a contract. ...
Yes, and suppliers are at the mercy of China, when China decides there is net gain to be had if US and EU are in depression, not buyers. China has been loading the economic gun that can send US and EU into depression for more than a decade. I expect they will not need to dump bonds to cause that depression - that GWB & republican "trickle down” economic have made it inevitable but Obama is a "wild card" that neither China nor I did not expect, so if Obama is also a "Keynesian miracle worker" China may need to fire that gun some day.
I am quite certain oil production will not permit 1.3 billion Chinese to live like 300 million Americans have. China has the means to see that they, not the USA buy most of that oil. We loaded the gun for them by two decades of living on their credit. China is now, and for the foreseeable future, the main market for car sales. India will also be competition for the resources critical to a live style on say the level of Western Europe. US's standard of living is declining and must come down to at least that level, but there appears to be now way that Asian oil and mineral demand increases will make even that level sustainable for India, China, US & EU.
Once I thought US military power might be used under some cover of "doing good" (making the world safe for democracy, etc.) to simply occupy oil producers. The experience in Iraq shows that it is too easy for a couple of men in the night with a sack of explosives to cut pipelines etc. - Iraq's oil production is still not back to pre-invasion levels. Our high tech army is ill equipped to secure oil production by occupation of oil producers. It is only good for destroying things, not protecting them, when they are 100s of km long and or spread over huge areas. China's huge man power army is better designed for that.
...Those delivery contracts are only a very small percentage of their reserves and China wanted something in exchange for their loans. I think it is just good business practices, not a policy change of shifting reserves from treasuries to contracts.
I think it is both. I also note that the rate of these "buy real assets" moves has greatly increased during the last 6 months. Chinese importers of ores, energy and to some extent food stocks, seem to now have a blank check for the central bank, but with the fall in commodity prices vs a year ago that too is just good business. China is filling it strategic oil reserve with cheap oil, etc.
...I don't know what you are on about here. China is making the loans in dollars, not bonds, and the contracts are a guarantee to deliver at market prices. If the dollar were to lose significant value, Brazil would receive more dollars for the same amount of goods. It is not a hedge bet, China would still lose purchasing power with those devalued dollars and Brazil would not be hurt.
True if the contract calls for dollar payment at "spot" prices. Many, if not most do not. Often the funds China supplies, even if it is supplying funds, will be parceled out of years. For example, Brazil just got promise of 10 billion dollars to help develop the pre-salt oil, and will pay back with 200,000 barrel of oil per day. (I don't know if the total volume of oil to be sent to China is fixed or if the the spot prices when delivered must accumulate to be 10B + interest.) If to be simple the funds come at 1B /years for 10 years and dollar purchasing power decreases during those 10 years to 1/3 of current value, and volume of oil is set in the contract, China just screwed Brazil, if the US is not in depression but with its demand and Asia's cause the price of oil to be $500/ barrel 10 years hence.
BTW, I think Brazil is stupid to be anxious to develop the "expensive-to-recover," deep, pre-salt oil now. Brazilian politicians just cannot resist getting their hands on the money with which they can effectively buy votes in simple make work jobs in rural areas. (Cut weeds along side of the dirt roads or make "sackcrete" patches of the pot holes in the paved ones that last about a year - longer fix is undesired so the pot holes can be filled again just prior to the next election. In many cases they literarily buy votes. My farm worker was a local leader in that valley. His wooden door on leather hinges was replaced by a politician with nice steel one and all he had to do was wear the politician's free T-shirt the week before elections. But I digress.)
In my post I mentioned that point (3) did depend on point (2) and the fixed or spot price if paid in dollars. Many are not even to be paid in any currency. For example, the deal that gets mineral from east Congo is paid by a new port and cranes for it plus railroad (rails, locomotive and rolling stock), to the mine areas, mining equipment, etc. all Chinese made of course. If the US & EU are not using much steel as in depression, then China will import the iron ore from Brazil and Australia cheaper from which it makes the port cranes and rails etc. to honor the contract. Often in Africa China delivers infrastructure, like dams, ports, hospitals, schools, railroads, computers, etc.
The basic idea is that China is trading skills and high value added items for supplies it needs to keep its factories busy without significant sales to the US and EU buying (as they are in depression and / or too broke to do so without Chinese loans.) As a buy-product of this, sometimes China also transfers dollar decline risk to the suppliers was my point (3) - like the above screwing of Brazil example if dollar declines over a 10 year transfer of funds and oil delivery volume of oil is fixed. When dollar decline will screw a supplier then that offsets some of China's losses on bonds it still hold thru the dollar decline. I called that "offsetting obligations" and noted in point (3) that to the extent China can structure these supply deals to transfer dollar decline risk to others they can safely hold corresponding value of bonds.
I hope what I was trying to state in point (3) is clear now.
