The US Treasury has declared it will issue a new batch of Treasury Inflation-Protected Securities (TIPS), to the great comfort of Beijing and the many other US creditors.
"This is a substantial step to guarantee China's dollar assets," said Yu Yongding, an expert at the Chinese Academy of Social Sciences. "The US economy is highly dependent on China. China must make use of its opportunities and maintain its own interests."
China has been seeking a guarantee for its $2.1316 trillion of assets since the outbreak of the financial crisis. US senior officials including Secretary of State Hilary Clinton and Treasury Secretary Timothy Geithner both promised to the Chinese government during their visits to China that the US has confidence it will avoid future inflation and that dollar assets are very safe. However, a promise is nothing without real action. "China must formulate detailed schemes and urge the US to take action," Yu says.
To Yu, the issuing of new TIPS is real action and a guarantee of the safety of China's dollar assets. "It's a most direct respond to China's requirements."
During the recent Strategic and Economic Dialogue held in Washington, the US government promised China that it would continue to issue TIPS. However, the Treasury did not reveal the scale of the issuance. "In its own interests, the US is unwilling to issue too many TIPS," Yu explained.
According to a Wall Street Journal report quoting Jeffrey Elswick, who is in charge of the fixed income department of Frost Investment Advisors, the scale of this TIPS issuance may reach $10 billion. From last October 1 to this June 30, the US has issued $6.66 trillion of national debt.
Issuing too many TIPS would be a frank admission by the US of future inflation. But with the whole world watching and questioning, the US is trying to prove that it can avoid inflation, maintain the dollar's dominance, and continue to lead the world.
Meanwhile, China must consider the costs of purchasing TIPS. Low risk means low rate of return. Since TIPS are a hedge on future inflation, naturally their rate of return will be lower than that of ordinary bonds. The interest rate is fixed but the principal can float, adjusted according to US CPI. Their anti-inflation guarantee means lower returns.
"But for China, it is most important to guarantee the safety of dollar assets. TIPS are a perfect choice," says Yu Yongding, once a member of the monetary policy committee of the central bank.
The US issuance of TIPS leads China to believe it has gained a response to its efforts to guarantee the safety of its dollar assets. Yu says, "China should be in constant contact with the US and look for action on any matter that is related to its own interests."
"Besides the safety of dollar assets, China is also calling for reform of the current international monetary system. A member of the expert committee of the UN General Assembly on Reforms of the International Monetary and Financial System, Yu Yongding suggests China should constantly monitor the US and raise requirements on detailed reform schemes. "For example, setting up a substitutional account inside the IMF is a necessary step in the reform of the international monetary system. As with TIPS, China should keep up a constant dialogue."