August 3, 2011 / 2:43 AM / 7 years ago

China warns of choppy Treasury market

SHANGHAI (Reuters) - China’s central bank governor urged Washington Wednesday to act responsibly to deal with its debt issues, saying uncertainty in the Treasuries market will undermine the international monetary system and hamper global growth.

The remarks by Zhou Xiaochuan, head of the People’s Bank of China, were China’s first official response to the passage of a U.S. deficit-cutting deal after weeks of bitter political wrangling that alarmed financial markets and brought the country to the brink of what some pundits predicted would be a catastrophic debt default.

Zhou welcomed U.S. progress in dealing with its debt problems but urged Washington to take what he called “concrete and responsible” measures to bolster confidence in U.S. Treasuries, of which China is a major buyer.

“Big fluctuations and uncertainty in the U.S. Treasury market will influence the stability of international monetary and financial systems, thus hurting the global economic recovery,” Zhou said in a statement posted on the central bank’s website.

“We hope that the U.S. government and the Congress will take concrete and responsible policy measures ... to properly deal with its debt issues, so as to ensure smooth operation of the Treasury market and investor safety.”

Due to the vast size and deep liquidity of the Treasury market, U.S. government bond yields are often the benchmark for the pricing of other financial assets around the world.

So a sharp spike in U.S. yields may roil markets and raise borrowing costs, endangering global economic activity. Investors who hold Treasuries as collateral would be hurt, too.

For China, which has repeatedly urged the White House to protect its dollar investment holdings, a jump in Treasury yields would be financially painful as it is the biggest creditor to the United States.

Zhou made the remarks after U.S. President Barack Obama on Tuesday signed into law a measure to cut spending and raise the U.S. debt ceiling, averting a default on government financial obligations.

“We welcome such progress,” Zhou said. “We will further study details of the measures and closely monitor how they would be implemented in various stages.”

Markets are now waiting to see if credit rating agency S&P cuts the prized U.S. AAA rating. The debt plan calls for savings of $2.1 trillion over 10 years, nearly half the amount S&P has said would be enough to support the current rating.

Moody’s and Fitch confirmed their AAA ratings Tuesday but threats of future downgrades remained.

Zhou’s comments come as a Chinese ratings agency cut its credit rating for the United States to A from A-plus, saying the latest debt deal does not improve the nation’s debt-paying ability in the long run <ID:L3E7J303M>.

With an estimated $2.1 trillion of its foreign exchange reserves — roughly two-thirds — invested in dollar-denomiated assets, China is particularly vulnerable to any default by the United States, or any significant fall in the dollar.

China has said it intends to diversify away from U.S. Treasuries. In an announcement last week, the State Administration of Foreign Exchange said it would press ahead with such moves.

Zhou Wednesday reiterated China’s intention to continue diversifying reserves. Still it has few good options.

The euro, by far the best alternative to the dollar, is also mired in the bloc’s debt crisis.

Although China has lobbied for the IMF’s Special Drawing Right to become a global substitute to the dollar as a reserve investment, it concedes such a system is years away from being adopted by the world.

Reporting by Samuel Shen and Carrie Ho; Editing by Jonathan Hopfner and Ken Wills

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