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The odds are good that China won't dump its holdings of U.S. Treasuries anytime soon. But by substantially reducing its purchases of U.S. debt - or halting them completely in the form of a buyers' strike - the Red Dragon could absolutely shatter the myth that it is the U.S. Federal Reserve that controls U.S. interest rates.
And that could also crater the bond market in the process.
According to the U.S. Treasury Department's Bureau of Public Debt, the U.S. national debt stood at $ 12,684,570,896,780.80 as of March 30. That's not a typo... we're talking about more than $12.684 trillion - or roughly $41,200 for every man, woman and child in this country.
By the time you read this, however, that number will be even larger: That's because the level of public debt is growing at an average of about $4.02 billion per day - and has been since September 2007.
Americans have become so used to hearing about the national debt, and so used to the huge numbers associated with it, that they've essentially become immune to the whole topic and just accept it as a fact of life. In doing so, unfortunately, they miss a very important point: In order for the federal government to borrow this money, someone has to be willing to lend it.
This really hasn't been an issue in years past because our government has financed the bulk of our national debt by regularly auctioning new Treasury securities of varying maturities - from as little as 90 days to as much as 30 years, generally speaking - to the public, which includes institutions such as banks and mutual-fund companies, private investors and, most notably, foreign governments and central banks.
As of the end of March, Treasury securities buyers held almost two-thirds of the total U.S. national debt, or roughly $8.2 trillion. That equates to about 56% of the U.S. economy's annual output, as measured by gross domestic product (GDP). The remainder of the national debt - about $4.48 trillion - is money the government owes itself as part of reserve funds for various programs, such as Social Security.
Although the massive national debt is troublesome, as is the continued deficit spending, we could probably live with this situation, assuming the economy continues its recovery. After all, government debt has been a major feature of American life for decades, now.
Unfortunately, the federal government keeps creating new debt, and trying to sell more Treasury securities to finance it, meaning the demand for those securities is falling sharply.
And by all indications, this decline in demand could get worse.
In fact, if you look at recent Treasury sales numbers, it appears that international buyers - led by China and Japan - are drastically reducing their purchases of long-term U.S. bonds, notes and stocks.
According to recently released data, foreign purchases of U.S. Treasury securities declined to a net total (total purchases minus total sales) of just $19.1 billion in January, down 69.8% from $63.3 billion worth of net purchases in December.
China accounted for a huge chunk of that drop, selling $5.8 billion more in U.S. debt securities than it purchased, which reduced Beijing's total holdings of U.S. government paper to just under $890 billion. This was the third straight month in which China was a net seller of U.S. debt, extending a downward trend that stretches back to July 2009, when China held almost $940 billion in U.S. Treasuries.
Japan, the second-largest foreign holder of U.S. debt, was also a net seller in January, with Tokyo's holdings falling to $765.4 billion, a decline of $300 million from the month before.
It's been more than a year since I first warned that this storm was brewing. Foreign governments were growing disenchanted with Washington's inability to keep its financial house in order, particularly since that escalated concerns about the safety of the U.S. dollar. On top of that, overseas central banks are exceptionally concerned about the U.S. Fed's insistence on maintaining artificially low interest rates - a more-recent development that's nevertheless exacerbating fears about the health of the U.S. greenback.
Those fears are finally coming to a head. Now, barring some quick policy actions in Washington, our foreign creditors may well take matters into their own hands - possibly even staging a "buyers' strike" against new U.S. Treasury offerings - ostensibly in an effort to force the Fed to raise U.S. interest rates.
In what would stand as a dramatic example of the classic supply/demand equation, the sharp drop in foreign demand for U.S. government debt in the face of the inevitable steady increase in supply could cause bond prices to plummet.
Couple that with the inverse relationship in the pricing of Treasury securities, and we would see bond yields zoom in order to attract sufficient buyers. Millions of investors would get crushed.
Historically, China has moved with practiced caution in this area. But as the fallout from the global financial crisis continues to play out, my sense is that as China's domestic markets gain power (and exports become less important) Beijing could react both quickly and decisively if it feels threatened, or even just insulted, as was clearly demonstrated in the recent showdown with Google Inc. (Nasdaq: GOOG).
Unfortunately, at least where China is concerned, there seems to be something of an ill wind blowing in Washington, with gusts that at times appear both threatening and insulting.
For some time now, the United States has been trying to get China to let its currency, the yuan, appreciate against the dollar, a move that would help stem a growing upward trend in the U.S. current accounts deficit - in simple terms, the amount by which the wealth (in all forms) that's flowing out of this country exceeds the wealth that's coming in.
For the last two years, China, in order to support its own balance of trade, has resisted holding the yuan steady against the dollar. By devaluing the yuan, China makes its exports seem cheaper to foreign consumers, which generates larger trade surpluses and brings in more cash to bolster the $2.4 trillion in foreign reserves the country already holds. China accounts for 31% of the world's foreign reserves, according to recent published reports.
As a result, Washington will decide later this month whether to declare China a " currency manipulator" - a seldom-used designation that would allow the United States to impose a variety of trade restrictions, including new tariffs, import quotas and the like. In my opinion - shared by many others who closely follow China-U.S. relations - that would undoubtedly provoke a trade war, in which both sides would ultimately lose.
More potentially damaging, however, would be a decision in anger by China to retaliate by completely halting new purchases of U.S. Treasury securities - a move that would severely hamper Washington's ability to borrow money to fund ongoing government operations and future deficits. This year alone, Washington will need to issue a record $1.6 trillion in new debt just to fund the shortfall between tax receipts and projected spending.
Indeed, it's highly likely that the big cutback in China's U.S. Treasury purchases we've seen during the past three months is meant as a warning of Beijing's willingness to play hardball. It's also a sign of China's growing unhappiness with Washington's spendthrift ways and the way in which the U.S. government has undermined the value of its own currency.
It's a warning Washington would be ill advised to ignore.
The United States would be better served to allow interest rates to rise to realistic levels, while also shifting the domestic focus from artificial "stimulus" to reduction of the federal deficit. Such a strategy would undoubtedly cause significant near-term pain. But it would put the U.S. economy on course for sustained, healthy growth, while simultaneously bolstering the nation's relationship with its foreign creditors.
If you see a similar scenario as inevitable, consider investments such as the ProFunds Rising Rates Opportunity Investment Fund (RRPIX), which is positioned to post substantial gains as interest rates rise.
You could also consider creating a hedging program of your own, using such exchange-traded-fund (ETF) investments as the SPDR Gold Trust (NYSE: GLD), or the United States Oil Fund LP (NYSE: USO). Those two ETFs closely track the world's two most actively traded "currency alternatives" - gold and oil.
Many governments around the world see this same trend unfolding. Those nations have already started establishing non-currency "reserves" as a hedge against this contingency, and are making serious investments in gold, oil, minerals and other commodities. With the long-term economic growth projected for China, India and other emerging economies, commodity prices are destined to rise in price anyway, which makes those commodities a sound investment, as well as a viable hedge.
It's a trend that U.S. investors would do well to note.
[Editor's Note: Money Morning Chief Investment Strategist Keith Fitz-Gerald is a perfect 22 for 22 with the recommendations made for his Geiger Index advisory service. It's a stunning record, but to those who know Fitz-Gerald well, it's actually not a surprise. A veteran trader, skilled analyst and noted market tactician, Fitz-Gerald is known for being able to see through the confusing haze of today's quickly changing markets to visualize and understand what the future really holds. This ability to predict looming changes is a key reason Fitz-Gerald is also able to divine the profit opportunities those changes will create. It's also a big reason he's been able to maintain a perfect track record with The Geiger Index. If you would like more information about the Geiger service, please click here.]
News and Related Story Links:
- Treasury Direct Official Web Site:
The Debt to the Penny and Who Holds It - U.S. Department of the Treasury:
Official Web Site
- Brillig.com:
U.S. National Debt Clock
- Bureau of Economic Analysis (BEA):
Official Web Site
- Wikipedia:
United States Department of the Treasury
United States public debt
- Bloomberg.com:
Roubini Sees Trade War If U.S. Calls China Currency Manipulator
MSNBC:
China steps up Google service disruptions- MarketWatch:
Bond Report: Treasurys head for biggest weekly loss this year
Asia Markets: Japanese, Chinese bank shares outshine benchmarks - International Monetary Fund:
Official Web Site
- China Daily:
China's forex reserves account for 30% of world total
About the Author
Keith is a seasoned market analyst and professional trader with more than 37 years of global experience. He is one of very few experts to correctly see both the dot.bomb crisis and the ongoing financial crisis coming ahead of time - and one of even fewer to help millions of investors around the world successfully navigate them both. Forbes hailed him as a "Market Visionary." He is a regular on FOX Business News and Yahoo! Finance, and his observations have been featured in Bloomberg, The Wall Street Journal, WIRED, and MarketWatch. Keith previously led The Money Map Report, Money Map's flagship newsletter, as Chief Investment Strategist, from 20007 to 2020. Keith holds a BS in management and finance from Skidmore College and an MS in international finance (with a focus on Japanese business science) from Chaminade University. He regularly travels the world in search of investment opportunities others don't yet see or understand.
Your analysis of the crisis and the threat to US dollar holder is on target, however the recommendation to invest in the GLD ETF (or for that matter SLV) creates other just as serious hazards given recent testimony at CFTC's hearing in Wash a week ago, where it was disclosed that the paper gold market is trading at 100 to 1 ( 99% is just paper not backed by physical gold): ergo it's just a PONZI scheme with lipstick. I would advise readers to look into Sprott's PHYS ETF, that is backed by actual physical gold, and whose shares can be converted into ounces for physical delivery, should investors should choose to do so.
Also recommended is the interview at King World News of Andrew Maguire, the British whistleblower, who helped lift the veil on the rampant corruption in the metals market:
I have written several cooments saying this same thing, over the last few months. So I totally agree with Keith. But the one thing that Keith missed is how pissed off China is that U.S.A. is selling $3.5 billion worth of armaments to Taiwan. Talk about spitting in Superman's face.
I am sure that that will be remembered when the time comes for China to consider whether or not they will be buying U.S. T-bills.
Excellent article. Money Morning lends credibility by speaking the truth although truth sure hurts.
Excellent article, but one item not discussed is the printing of money and Fed reserve purchasing of Tréasury Bonds issued, ("Quantitative Easing"). They are doing this to manipulate the interest rate of the bonds plus increase the money supply.
The US throught he Federal Reserve will pay the interest on the bonds by printing money and could probably do this for about 20 years of so, it will create some inflation but I am sure that is the plan.
Military spending, entitlements, etc, if no cost controls are implemented and no additional revenue stream is created the´n we are headed for a crisis, but in my opinion it is about 15 to 20 years down the road, so we do have time to correct things, but am not sure the wiill of Wall St, the US Congress and the American people are ready to do so.
In other words, we become a larger version of Greece.
FB
China, Japan and other countries could be doing U.S. a favor by reducing purchases of U.S. securities. The U.S. then would be forced to live within its own means, take the pain, and not live on the credit of other countries. Of course, the U.S. still has another source of revenue or tool at its disposal to manipulate our economy: the printing press to float new money. That is a powerful tool and a strong hand. If the printing press is judiciously utililized, and only as a last resort, the U.S. should be able to keep its economy growing while dampening inflationary pressures. In the meantime, the dollar will be the world's dominant currency for some time to come, so don't hold your breath for its demise. It won't happen, if ever, in our lifetime. Hold gold anyway for its own sake.
I marvel at what our current administration is doing to get the U.S. out of its doldrums on several fronts:
1. Engaging in a slow economic recovery to make needed corrections as the economy heats up slowly. It is easier to make corrections in a slow growing economy than an economy that is growing rapidly.
2. Adopting a much needed national healthcare reform.
3. Going green and becoming less dependent on big oil.
4. Making mutual agreements with Russia to reduce our nuclear arsenal and focussing on rogue nations like North Korea and Iran.
5. Engaging in education reform to help poor performing students and providing direct loans to college students, thereby, saving money by bypassing commercial lending agencies.
6. Confronting China to raise the value of the yuan to correct a wide trade imbalance.
7. Engaging in bailing out troubled corporations and distressed mortgage holders who, if left unattended, would create more needless pain and suffering.
8. Helping to restore some semblance of democracy in countries like Iraq and Afghanistan before leaving.
9. Fighting El Quaida and terrorists and protecting the security of our country.
President Obama's administration is tackling the hard issues facing our nation head-on. In stark contrast, it is much, much more than what our Hawaii leaders are doing in our State to correct our own economic problems, which amounts to almost nothing, like they are in a state of paralysis. They are so filled with fear they sideskirt the main issues facing our State while our lameduck Republican governor keeps slashing away at State jobs and longstanding State programs to maintain a balanced budget a year before she leaves office at the detriment of the people she is supposed to be serving. It is going to take years to correct the damages she is inflicting. With poor leaders, people suffer. Imagine if our President were acting like our Hawaii State leaders. All hell would have broken loose in our country with a do nothing President. We should be thankful we have a strong, wise President who is proactive and gets things done the right way and doing things which are for the good of the country and not by acting out of spite and/or revenge.
From all this rhetoric, the U.S. has one remaining major issue that needs to be resolved: reforming our financial sector. Shah Gilani does a great job clarifying the issues and pointing out remedies. Shah for Treasury Secretary? In my humble opinion, he would be a good one.
We can let rates rise. But we will have to increase taxes. This is a democracy and when Keith talks about severe short term pain that means a substantial chunk of the citizenry that have lost a lifetime of capital accumulation.
Honestly I am not that worried about China. This is not a serious country. They have 60 million people who want to be part of the west coast of America. And another 600 million who are living in sub-Saharan African poverty. There natural resources are limited and they lack a system of government that harnesses the inate creativity of its people. Totalitarian regimes are always bad for business. Read George Friedman.
I do not like these typifying titles like "Red Dragon" – remember those "Asian Tigers" about a decade ago or so? Beware of hubris or hybris.
What should a US citizen do with do with EE BONDS purchased. in the last 8 years then? Are they worthless?
If what you are writing in this artilce is true, why the US Dollar is getting stronger in the last 2 mounths in my country (Romania). Can somebody explain?
I am very interested in the US Dollar evolution because I have business with US companies.
I mus say also that I highly aprecciate your articles.