China may sell U.S. bonds

The Chicago Tribune reports:

In a move that speaks to China's growing significance in the global economy, its government said Friday it will look for more aggressive ways to invest sizable portions of its massive $1 trillion currency reserves.

The new Chinese pool of money, expected to total $200 billion to $300 billion, would instantly create one of the world's most powerful investment funds, analysts said.

With much of China's $1 trillion in reserves currently invested in ultrasafe U.S. Treasury debt, a significant shift out of the American bond market could have an impact on American consumers. Interest rates would rise, making it more expensive to borrow money for a home mortgage or car loan or to pay credit card debt.

Chinese officials said they planned to form a government investment firm to manage some of its holdings, an indication that China has tired of earning small and predictable returns and wants to look elsewhere.

"It's entirely possible that they are ready to diversify their investment portfolio," said economist John Silvia of Wachovia Corp., who predicts that any changes would not come quickly.

The Chinese have been threatening for several years to look in new places for safeguarding their ample reserves.

For Americans, "this will be a challenge, no doubt about it," Silvia said. "It likely will mean higher mortgage rates and a weaker dollar. But these effects could take 5 or 10 years to be fully felt."

Huge holdings of Treasury bonds by both China and Japan have been taken for granted by Americans for the last decade. Their involvement in debt markets has helped to hold down long-term interest rates, especially for mortgages.

Less demand for U.S. debt means higher mortgage rates.Plus,in the next 10 years Social Security and Medicare should be much larger.