It’s not often that the words “bond” and “attack” are part of the same headline, but that’s exactly what appeared in the Sept. 19 edition of the Daily Telegraph.
The story, titled “Beijing hints at bond attack on Japan,” is a telling look at China’s economic policy — and it’s one that carries some important implications for the United States.
The background is this: Last week, the Japanese government purchased three uninhabited islands north of Taiwan from their private owner. The islands are a source of longstanding dispute, as they are strategically important and claimed by Japan, Taiwan and China. (Shown to the right; graphic via Washington Post.)
Japan’s move has led to threats from the Chinese government and sparked numerous protests throughout China. The Chinese government also is threatening to cut off exports of rare-earth minerals to Japan.
Although friction between Japan and China is nothing new, the Telegraph article offers some key points that make it essential reading for anyone with cash invested in the financial markets. Three highlights from the article stand out:
Japanese Exports at Risk
China’s worst threats might be unlikely to come to pass, but the shutdown of Japanese factories and potential for lost exports to China are real. This quote from the article is key:
“Fitch Ratings threatened to downgrade a clutch of Japanese exporters if the clash drags on. It warned that Nissan is heavily at risk with 26pc of its global car sales in China, followed by Honda with 20pc. Sharp and Panasonic both have major exposure. Japan’s exports to China were $74bn in the first half of this year. Bilateral trade reached $345bn last year. Mr Jin said China can afford to sacrifice its ‘low-value-added’ exports to Japan at a small cost. By contrast, Japan relies on Chinese demand to keep its economy afloat and stave off ‘irreversible’ decline.”
While Japanese ADRs and the iShares MSCI Japan Index Fund (NYSE:EWJ) have held up well so far, this dispute is a must-watch for investors who own these securities until a resolution appears to be at hand. If nothing else, boycotts of Japanese goods — which have been encouraged by China’s state-run media — could lead to short-term pressure on the results of Japan’s major exporters.
Is Japan the Next Europe?
Again, the odds of a worst-case scenario are low. However, there is some tail risk created by this event caused by the possibility that China could “impose sanctions on Japan in the most effective manner and bring Tokyo’s festering fiscal crisis to a head,” as the article puts it. With the Europe issue off of investors’ radar screens for the time being, this issue could nonetheless put a spotlight on the country’s perilous finances even if — as is most likely the case — it doesn’t bring Japan into a similar crisis scenario as Europe.
China’s Use of Bonds as a Weapon
For the United States, this is the key aspect of the dispute.
The consensus view has long been that China wouldn’t take the chance of wholesale selling off its position in U.S. bonds, since it would drive up rates and hurt the value of its remaining position. Still, the fact that this is being raised as an issue shows that such a move is in fact on the table in a dispute.
This matters for the United States because China holds $1.15 trillion of our debt, according to the most recent U.S. Treasury data, which means that it holds more than 20% of all U.S. debt held overseas. This recent article in the Telegraph shows that in any future disputes with the United States, China might not be afraid to engage in saber-rattling with its most dangerous weapon: its influence over U.S. interest rates.
Right now, China’s talk is just that — talk. But the way China handles this situation could provide a clue regarding the extent to which it plans to wield its economic power in the years ahead.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.