From The New York Times…

The Chinese prime minister, Wen Jiabao, spoke in unusually blunt terms on Friday about the “safety” of China’s $1 trillion investment in American government debt, the world’s largest such holding, and urged the Obama administration to offer assurances that the securities would maintain their value.

If that does not worry you, read the Wall Street Journal article…..

The Obama administration rejected China’s concerns that its vast holdings of U.S. assets might be unsafe, in an unusual diplomatic exchange that underscored the global importance and the potential fragility of the Sino-U.S. economic relationship.

In a coordinated response to blunt comments from Chinese Premier Wen Jiabao, White House officials said Friday that Mr. Obama intends to return the country to fiscal prudence once the crisis passes.

“There’s no safer investment in the world than in the United States,” said presidential spokesman Robert Gibbs.

Every time during this current crisis someone has claimed that something was safe, it has run into trouble within six months. But such worries are old hat. If all there was to this story was somebody expressing worry about the ability of the Untied States to handle its debt load I would not even bother posting it. But what is more interesting about this story is how everyone seems to be willfully misinterpreting it.

This story has been all over the news, and yet everywhere I go people are talking about how China is looking for assurances. But that does not come close to passing the smell test. You don’t have a leader of a country seek assurances. You do that through private diplomatic means. When a leader of a country speaks, it is to shape public perception and to warn the world about actions that might be forthcoming.

Yet everyone is bending over backwards to convince themselves that this is nothing more than China looking for assurance. Every article on the subject is filled with experts who assure us that China has not real choice and that it must continue to buy US assets. I think Brad Setser falls into this trap when he says…..

1) China both wants to maintain the RMB’s link to the dollar and avoid adding to its already large dollar exposure. Yet so long as China pegs to the dollar and runs a sizable current account surplus, it is hard to see how China can avoid adding to its dollar holdings.**

2) China is torn between its interest as a creditor and its interests as an exporter. China’s commercial interests would be best served by an even larger US stimulus, one that helped spur US demand for China’s goods. China’s reserve managers though worry that the US won’t be able to finance a large stimulus and thus are worried that a rise in Treasury supply would reduce the value of China’s existing Treasuries.

The problem with Mr. Setser’s analysis is that he assumes that the question of what is best for China’s economy and the question of what is best for the value of China’s reserves are two separate issues in the minds of China’s policy makers. But while this was certainly true is the past, there is no reason to assume that this is true today.

In the past it was clear that China was willing to sacrifice the value of its reserves in order to facilitate economic growth. But that was back when China was exchanging the value of its reserves for a booming trade surplus. Today China’s trade surplus is falling like a rock. In January, China’s trade surplus was $39.1 billion dollars. In febuary, its trade surplus was only $4.84 billion dollars. If China’s trade surplus keeps falling at its current rate, China will swing into a trade deficit next quarter. If that happens, China will need to sell some of its dollars assets to fund its imports.

This scenario is currently regarded as unthinkable by most commentators. But it is the logical result of China trying to stimulate domestic demand. In fact, if China wants to prop up domestic demand (like it has promised to do) without running a huge fiscal deficit (like it has promised not to do) then they have no choice but to engage in a massive sell down of their reserves.

So the reason that China is making it very public that they expect the US to insure the value of China’s investments may have something to do with the fact that China is starting to think that it may need those assets to keep its own economy afloat.

Regardless of whether I am right or not, the idea that that Prime Minster of China is looking for assurance is bunk. The US government has already committed to standing behind the agency debt. The treasuries have it in writing that they are backed by the full faith and credit of the US government. How are more words going to assure the Chinese? There is something more going on here.