What China's Treasury Liquidation Means: $1 Trillion QE In Reverse

Tyler Durden's picture

Earlier today, Bloomberg - citing the ubiquitous "people familiar with the matter" - confirmed what we’ve been pounding the table on for months; namely that China is liquidating its UST holdings. 

As we outlined in July, from the first of the year through June, China looked to have sold somewhere around $107 billion worth of US paper. While that might have seemed like a breakneck pace back then, it was nothing compared to what would transpire in the last two weeks of August. Following the devaluation of the yuan, the PBoC found itself in the awkward position of having to intervene openly in the FX market, despite the fact that the new currency regime was supposed to represent a shift towards a more market-determined exchange rate. That intervention has come at a steep cost - around $106 billion according to Soc Gen. In other words, stabilizing the yuan in the wake of the devaluation has resulted in the sale of more than $100 billion in USTs from China’s FX reserves. 

That dramatic drawdown has an equal and opposite effect on liquidity. That is, it serves to tighten money markets, thus working at cross purposes with policy rate cuts. The result: each FX intervention (i.e. each round of UST liquidation) must be offset with either an RRR cut, or with emergency liquidity injections via hundreds of billions in reverse repos and short- and medium-term lending ops. 

It appears that all of the above is now better understood than it was a month ago, but what’s still not well understand is the impact this will have on the US economy and, by extension, on US monetary policy, and furthermore, there seems to be some confusion as to just how dramatic the Treasury liquidation might end up being. 

Recall that China’s move to devalue the yuan and this week’s subsequent benchmark lending rate cut have served to blow up one of the world’s most popular carry trades. As one currency trader told Bloomberg on Tuesday, "it’s a terrible time to be long carry, increased volatility -- which I think we’ll stay with -- will continue to be terrible for carry. The period is over for carry trades."

Here's a look at how a rules-based carry strategy designed to capture yield differences would have fared in the universe of G10 CCYs (note the blow ups around the SNB's franc shocker and the yuan deval):

In short, the music stopped on August 11 and to the extent that anyone was still dancing going into this week, the PBoC’s decision to cut the lending rate along with RRR buried the trade once and for all.  

Estimating the size of that trade should be a good indicator for just how expensive it will be - i.e. how much in Treasurys China will have to liquidate - to keep the yuan stable. The question, as BofAML puts it, is this: "can China afford the unwinding of carry trades?"

The first step is estimating the total size of the trade. Although estimates vary, BofAML puts the figure at between $1 trillion and $1.1 trillion. Here’s more: 

As analyzed above, the size of RMB carry could be quite high and thus exert downward pressure on RMB. But the PBoC should have scope to defend its currency if necessary. The PBoC’s toolbox includes its $3.65tn FX reserves (at end-July), as well as measurements to tighten FX controls on individuals, corporate and banks, if necessary, including imposing stricter requirements on NOP, among others. 


That said, we doubt if the PBoC will persistently intervene as rapid decline of FX reserves undermines market confidence anyway and imposes challenges to the PBoC. Alternatively, the PBoC could impose stricter FX controls but that would be considered as a backward move of capital account opening up. Nevertheless, we believe the PBoC intervention will still have spillover effects on the market. 

In other words, if this entire $1 trillion trade gets unwound, China will need to offset the pressure by either i) draining its reserves, or ii) taking a big step backwards on capital account liberalization. The latter option would be bad news for Beijing’s efforts to liberalize markets and land the yuan in the SDR basket. 

Of course, as noted yesterday and as tipped by SocGen earlier this week, the liquidation of $1 trillion in FX reserves would put enormous pressure on domestic liquidity, tightening money markets meaningfully, and forcing the PBoC to cut RRR 10 times (assuming 50 bps intervals). As BofA notes, China can’t "afford another liquidity squeeze like June 2013 given very poor sentiment nowadays and China’s economic downturn."

Putting the pieces together here - and here is the critically important takeaway - we know that the size of the RMB carry trade could be as high as $1.1 trillion. If that entire trade is unwound, it would require China to liquidate a commensurate amount of its reserves in order to keep control of the yuan - or else resort to FX controls. Here's the point: if China were to liquidate $1 trillion in reserves (i.e. USTs), it would effectively offset 60% of QE3.

Furthermore, based on Citi's review of the academic literature which shows that for every $500 billion in EM reserves liquidated, the yield on the US 10Y rises 108bps, if the PBoC were to use its reserves to offset a hypothetical unwind of the entire RMB carry trade, it would put around 200 bps of upward pressure on 10Y yields.

So in effect, China's UST dumping is QE in reverse - and on a massive scale. Facing this kind of pressure the FOMC will at the very least need to exercise an exorbitant amount of caution before tightening policy and at the most, embark on another round of asset purchases lest China's devaluation and attendant FX interventions should be allowed to decimate whatever part of the US "recovery" is actually real. 

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LawsofPhysics's picture

Yes, for us maybe, but for every seller there's a buyer right?

Interest rates in Brazil are high by comparison, look how well they are doing...

knukles's picture

This is exactly what several of us were discussing here yesterday.  The whole sthick is essentially "re-normalizing rates" through a tightening of monetary policy which is essentially a decision out of the Fed's hands.  To which they must respond in order to neutralize.... as in QE4evah

The unintended consequences of these NWO, Central Planning, idiotic policies are breathtaking.

This is not gonna end well.  In fact rather poorly.  Errors of co-mission and omission cannot be compounded and expected to be benign.

Bay of Pigs's picture

I'm onboard the Doom Train and hoping for several 1000 point daily drops in Sept.

Time for the Wrecking Ball to swing on Wall Street.

TongueStun's picture
TongueStun (not verified) Bay of Pigs Aug 27, 2015 7:08 PM

Read "Don't Fuck With The Tiger" by Claude Bawls

johngaltfla's picture


The ChiComs are preparing the world for a dollar reserve status exit. Once they reduce holdings to 25-35% of current holdings they will press the issue.

At that moment, we are fucked. Worse than anything anyone could imagine.

BurningFuld's picture

Float the Yuan. Dump the Treasuries. WTF are you waiting for!

johngaltfla's picture

BF, about 12 more weeks of liquidation of long term UST crap. If the Middle East cartels join in and absorb the Reminimbi, then all the better. The USD will be toast once the US Trade Weighted crosses the 150 mark anyways.

BurningFuld's picture

I'm thinking it all hinges on the Saudis. The day they take other than USD for oil it is over. Other than overt bankruptcy of the USA that is. What ever happens first.

Motasaurus's picture

The Saud's don't do anything without London's O.K. Same for Wallstreet. Same for China. 

You watch. At the end of the day London will come out on top, ruler of whatever ruins are left. 

cnmcdee's picture

Tomorrow is Judgement Day in the markets?  A homeless guy spends an entire week warning people that the stock market is going to crash on Aug 28, 2015?

NoDebt's picture

<---- Yes, 10 year 200bps higher

<---- Not a chance in hell

J S Bach's picture

This is what happens when you have international usurers in charge of the world's money.   A nation like the U.S. - long ago beheaded of its founding ethics and principles - gives the power of issuing its once sovereign money over to aliens who have no loyalty to any people but their own.  So, a country like China can - for years - "buy" our debt so that we may foolishly live the undeserved grasshopper lifestyle for decades.  Well, winter is fast approaching and the ants are barring their doors.  No more free lunches for America or any other debt-riddled nations.  More QE is sure to come until it all explodes in our faces.  Learn people... learn.  When the time comes to rebuild, understand and live what is right and true.  Use all of your power to advocate for sound sovereign debt-free money.  We mustn't allow our progeny to suffer under this insane irresponsible nonsense ever again.

3rdWorldTrillionaire's picture

Yeah, you mooks!

Seriously though, we are all so fucked...

Dutti's picture

WOW, guess I have to change my position from long to short right now when I hear this enlightened prediction.

MANvsMACHINE's picture

Actually, your wife tells me she wishes you were longer.

SilverRhino's picture

Looks like there is a retail silver shortage developing.    

I've NEVER seen silver.com or kitco run out of silver rounds.   



SilverRhino's picture

  • 30% premiums on ASE, Maples and Phils
  • 50% premiums on junk silver 
  • 15% premiums on private silver rounds. 
  • Now 100 ozt bars?  2.9% premium 
    • Spot's at 14.44 / 14.54 .... just got one from Provident for 1497.00 

I think we found our bottom.

bigkahuna's picture

If we have, I might have to go visit the site of my boating accident.

NeoRandian's picture

Good reason to go ahead and nuke London now just to be sure that no conspirators get away with it unscathed.

Justice for all.

claytonmoore50's picture

"I'm thinking it all hinges on the Saudis. The day they take other than USD for oil it is over."

Don't forget that the Saudimites depend on that U.S. Aircraft carrier battle group that is permanently in the gulf that is really there to protect and support the House of Saud in return for the exclusivity of the Petrodollar.

If they screw with that status quo they may see regime change that they don't want

OpenThePodBayDoorHAL's picture

Except that we have total friggin' amateurs behind the wheel in Washington, at least when Kissinger and Volcker were at the big boy table they knew the rules of the big boy game, instead we got the Chicago social worker, a bunch of Chanel-suited Berkeley-ites, friggin' clueless Jack Friggin' Lew, and lil ol' Grandma Yellen. We are so screwed

mkkby's picture

The saudis WON'T DO SHIT.  That aircraft carrier is the only thing keeping those kings and princes in power.  Withdraw US support and their own people behead them within a month.

fiftybagger's picture

"U.S. Aircraft carrier battle group that is permanently in the gulf"

How many of these do you think China can pump out once they set their minds to it?  I'd say one a month, easy.


Chinese aircraft carrier Liaoning



Numbers of aircraft carriers by country

QE crack addict's picture

It takes 5 to 10 years to build one aircraft carrier. I believe we have 16. Someone can double check that for me. I think the runner up has only 2. The modern aircraft carrier serves as the center piece, the queen in  hess if you will, in projecting military power abroad.

He's right, the House of Said would never risk it.

China or anyone else is decades, if not a century, from supplanting American military hegemony.

SDShack's picture

Aircraft carriers will be useless in about 20 years as missle technology, specifically Anti Ship Ballistic Missles become common. Drones will also play a part. The next big war will showcase this, and the consequences will be devestating for traditional US Naval Power. Just like the Aircraft Carrier destroyed the Battleship, anti ship missles will destroy the carrier. Submarines are another story. They will be the prominent chess piece of the navy because of better survivability, not carriers.

Calmyourself's picture

John, expand on this, the Chinese will be as hurt as anyone else is my understanding, like your writing and your site, flesh it out..

johngaltfla's picture

If one is preparing to save their own currency and economy by leaving a dollar peg and vaulting their own into the reserve or part of a global reserve currency, the Chinese have to liquidate their US holdings first. You can only buy so much freaking copper and oil so the next step is to stabilize their own currency and economy by getting rid of USD and eventually the peg.

The problem is now that word is out, it will not happen slowly and as throughout history, it happens rapidly; unfortunately WWII was an example of how it happens and how the Pound Sterling became irrelevant. The US will probably start a Middle East war to save itself but will fail.

NoDebt's picture

It's a good point to bring up military conflict, since this is where it's headed.  But your extrapolation on the WWII analogy isn't correct, in my humble opinion.

For China to muscle a "reserve currency" status for itself militarily they would have to do one of the following:

1.  Win a war we can't.  (For example, bringing Iran to heel would do it- clearly we can't)

2.  Directly defeat the US Navy in some Pacific conflict.  They wouldn't even need to defeat us outright, just deny us a victory that was clearly strategically important to us and that we stated we would achieve.  In short, make an ass out of us.

Its your basic dog psychology- prove they are stronger than the US, thus shaking confidence in the US and building confidence in China.

This all presupposes they even WANT reserve currency status for the Yuan.  Which is likely, but not assured.

jeff montanye's picture

 In short, make an ass out of us.

imo russia and china are doing that day after day without firing a shot.

and i say good riddance to those who make it so easy to do.


maxwellsdemon's picture



Why would China want to be the reserve currency, when Triffin's paradox would predict that China would then lose it's manufacturing base.  China doesn't want to lose it's manufacturing base and therefore in my opinion, it doesn't want to have the yen become the new reserve currency.  Only imperialistic countries such as the US and Britain before it, have purposely tried to set up reserve currency status for their national currencies, but only as a means of creating the stage for financial imperialism to occur.  Financial imperialism (or 'imperial bankism') needs an expansionist military arm to enforce the rule that loans in the reserve currency must be repaid by subject states only in the reserve currency, thus establishing that the reserve currency has 'value'.   At first, gold backed currencies were reserve currencies, but the banks didn't like losing any gold in maintaining their finanical hegemony over client states, so beginning with England in the 1920's, gold backing of the reserve currency of the day has been replaced by military backing of the reserve currency.


But if China's dumping of Treasuries results in the Fed not soaking them up by offerering treasuries at higher rates (which would killl the value of bank loan portfolios), so that instead, dollars flood the market as the Fed becomes the only purchaser (and thus creates money out of thin air to buy these bonds from China), then the prices of commodities in dollars would rise.  That is the most likely scenario, that dollar inflation will occur and that will be the demise of the dollar as reserve currency since only draconian military control of foreign countries can maintain reserve status of a depreciating currency and it will become impossilbe to enforce the reserve status everywhere at once.

China doesn't want to control other countries, only participate in peaceful trade.  Control of foreign countries is foreign to the Chinese culture.  Not so for the tribe of bankers that controls the West since to them, which consider every one of us to be foreignors to them, as they have for hundreds if not thousands of years.




Jack&#039;s Raging Bile Duct's picture

Your statement has no basis in historical fact. China has a long history of forcing its geographical neighbors to pay tribute for the priviledge of not being invaded. That being said, China possesing a reserve currency would be disaster to its merchantist economy. I suspect that China's owners realized some time ago that, indeed, merchantilism doesn't work beyond a certain point and are attempting to transition. That's not an easy proposition for an economy as large as China's. To say that balancing domestic stability with foreign market dominance is an understatement.

SilverRhino's picture

Don't forget the kowtow that was required of imperial tributaries in order to be able to even trade with the Chinese.   

Pecking order 

  • Chinese 
  • Korea / Vietnam
  • Ryushu and some other tributaries 
  • English / Portuguese
  • everyone else.
  • and then Japan .... who were never allowed trade
CC Lemon's picture

Best case for China is they get the Yuan in the SDR basket. That's even a year or so away.

They will NEVER be the reserve currency. 

Nobody trusts China.


They can't project military strength.


And most importantly, they have no bond market to speak of. No fool's gonna hold Yuan backed securities when China has revolutions every 50 years or so.


We may be heading towards NO reserve currency.



the Feds end game is for the dollar to DESTROY AlL OTHER CURRENCIES.


who the fuck knows

mvsjcl's picture

I agree with "who the fuck knows." But what I'm stoutly sure of is someone sure the hell does know. That person ain't talking to us, though.

zvzzt's picture

Agreed, but not sure if US is fucked by losing the reserve stsatus. Mentally sure, but politics should get more 'global friendly' (i hope) and a strongly weakened USD could get the lazy and especially complacent asses of the sheeple working again rather that borrowing and spending. Then they get the chance to actually make things again and try to sell it to the rest of the world.

No doubt the intermediate phase will be horrendous, especially with the .gov trying to blame all the shit on other countries.... On the longer term, I think it would be a good thing - if the world survives the call to arms and propaganda of course.... 

Obama LaForge's picture

No, the Chicoms, realizing the jig is up, is going to emigrate TO America before the guillotines get rolled out. And are they going to need? US dollars. Dollar bull!

Sh0t's picture

This is my view.


China has to unload slowly before the next currency order or they will take a huge hit. Once China's holdings of US paper are low, it will be a whole new ball game. 

Sh0t's picture

This is my view.


China has to unload slowly before the next currency order or they will take a huge hit. Once China's holdings of US paper are low, it will be a whole new ball game. 

Tarjan's picture

And do not forget that Xi meets with Obola later in September.


junction's picture

The actual title was "The Tiger's Revenge" by Claude Balls, a joke from 55 years ago.  A joke ahead of its time.  Another book title was "The Yellow River" by I.P. Daly.

Whodathunkit's picture

And "Over the Hurdles" by Won Hung Lo

Kinskian's picture

"Race for the Toilet" by Willie Makit, illustrations by Betty Wont.

jeff montanye's picture

under the bleachers by seymour butt.

MsCreant's picture

Brown Spots on the Ceiling, by We Fling Poo.

StychoKiller's picture

"Holes in the Mattress," by Mr. Cumpletely

fiftybagger's picture

6 After this I beheld, and lo another, like a leopard, which had upon the back of it four wings of a fowl; the beast had also four heads; and dominion was given to it.

King James Bible Daniel 7

realmoney2015's picture

I heard on the radio today over and over that the stock market is not the economy. Its funny that they have been saying that the economy has been growing and improving the past couple years and pointing to the stock market as proff. Now that they know its about to tank, they call the stock market the economy for the 1%!

What a joke! Let's get it over with and bring the Dow and the Dollar to zero already. Time to reset. Hopefully we can start agian with a real, honest, free market system.