Nonstopdrivel
14 years ago

April 7, 2010
How to Protect Yourself And Even Profit if Foreign Creditors "Strike" U.S. Treasuries 

By Keith Fitz-Gerald, Chief Investment Strategist, Money Morning
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.



I've been warning about this for a couple of years now. I think the faucet of lending to the US is slowly being turned off. I think the flow really started to get restricted when those mysterious Chinese emissaries visited Fed Chairman Paul Bernanke last November, and the next week Secretary of the Treasury Timothy Geithner announced that there would be no more stimulus spending and that the federal government must begin to work on paying down the deficit. I think those Chinese emissaries basically whispered in his ear, "Look, the free-for-all is coming to an end. Get your shit in order."
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Nonstopdrivel
14 years ago
For an alternate viewpoint:

3 reasons investors love this week's new $82 billion in Treasury debt 
By Katie Benner, April 7, 2010: 1:37 PM ET


(Fortune) -- This week alone, the Treasury Department is selling $82 billion in new debt to investors. If that sounds like a lot, it is. The Treasury has been issuing many times more debt than ever before to fund the massive Obama Administration spending programs.

The amount of supply hitting the market has caused handwringing over whether investor demand can keep up and continue to fund America's staggering deficits, with this week's debt auctions billed as a test of appetite for U.S. government debt.

But it's a test the government has already passed. Here's how and why:

Demand is setting records

Demand for Treasuries simply isn't going away. Rumors that foreign buyers will abandon U.S. debt are being greatly exaggerated. It's true that last month's $118 billion two-year note auction was lackluster, but analysts say that's due to spring holidays and overseas bookkeeping. "Buyers in Asia sat on the sidelines, because it was their fiscal year end," said Rich Bryant, head of Treasury trading at MF Global.

Now that we're back to routine, American banks and insurance companies are rejoining foreign investors and pension plans in the upcoming Treasury auctions. Thanks to upcoming financial reform, firms are preparing to hold more capital in reserve, so they'll invest in liquid, triple-A rated securities. That's the definition of a Treasury. Since those same firms can borrow money at nearly 0%, a 4% yield on 10-year notes is basically a risk-free moneymaker.

Treasuries are such a good deal right now that the bid-to-cover ratio for the last few months has run between two-to-one and three-to-one. That means there have been two or three bids submitted for every one accepted. This Monday's $8 billion Treasury Inflation-Protected Securities or TIPS auction had a record ratio of over 3.4, and Tuesday's $40 billion three-year note auction had a ratio of 3:1. That's strong demand for such a big volume week.

Dollars-denominated investments rule the globe

Investors who need dollar-denominated assets don't have a lot of options right now. Debt from the United States is practically the only game for now. The exotic instruments that brought about our financial crisis are frozen up or simply not being offered right now. With asset-backed securities and CDOs having fallen away, the only dollar-denominated debt issuance of institutional quality are Treasury notes and bills.

Real recovery is a long way off

Third, the Federal Reserve is making noises about raising interest rates to fight inflation, but few analysts believe such a move will happen in the next few months. Officials may say the economy is improving, but that doesn't mean they believe it's time to start cooling it off by raising rates, either. Bond traders tell Fortune that they don't see a rate hike until the end of the year, or the beginning of 2011.

Even if inflation happens, there's a lot of real-world slack in manufacturing and jobs that needs to tighten before the Fed could deploy interest rate hikes as an inflation-fighting tool. At the most recent Fed meeting, policymakers said that the recovery could slow in the coming months, which makes a hike even more in doubt.

Some economists are predicting a double dip recession, which would mean a rate hike might not come until the end of this year, possibly not until 2011. Investors usually turn to equities when they are worried about inflation eating up bond returns, but that's not yet happening. Instead, the inflation-protected TIPS auction drew a record level of interest; since investors are still loathe to take on any kind of risk while the macroeconomic scene plays itself out.

It's valid to ask whether America's $82 billion of borrowing this week is a condition to be pleased with. Though this week's auction pales in comparison to the $123 billion record week of Treasury auctions held in October 2009, just two years ago, the country didn't come close to borrowing that much in an entire month.

But right now the U.S. government is still the most desirable and valuable game in town for pension plans, insurance companies, banks, and even foreign governments. Until securitizations come back and a strong recovery takes hold of this country, expect months of strong auctions ahead, with investors scooping up billions more dollars of our national debt.


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Nonstopdrivel
14 years ago

US Treasury Markets
Treasury Department Auctions $21 Billion In 10-Year Notes 
4/7/2010 1:34 PM ET

(RTTNews) - The Treasury Department announced Wednesday that it has auctioned $21 billion in 10-year notes, with an increase in demand.

The auction featured a bid-to-cover ratio of 3.72. It also featured a stop-out rate of 3.900 percent.

The last 10-year notes auction took place on March 10. It saw the sale of $21 billion of the security, a bid-to-cover ratio of 3.45 and a stop-out rate of 3.735 percent.

A bid-to-cover ratio is a measure of demand that indicates the amount of bids for each dollar worth of securities being sold.


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Porforis
14 years ago
I don't always agree with you, but you always seem to have good insight into most things political and economic... Do you see any chance of a VAT not being imposed before the 2012 elections? I don't see any signs of the federal government reigning in spending, so logically I assume that even IF the amount of money lent to us WASN'T drastically reduced, I figure that they need to impose a massive tax sooner or later anyways.
Nonstopdrivel
14 years ago
This is an excellent question, and one for which I don't have an answer. I think we as a nation probably should go to a VAT model, but I have to think the American people would be highly resistant to that idea. They aren't used to paying upwards of 20% on every purchase, which is what a VAT would entail. The problem is that I think a VAT would be imposed on top of all the taxes we already have, when it should be used as a substitute for some of our more questionable taxes, like property and income taxes.

Though Americans don't realize it, they actually pay some of the lowest taxes anywhere in the Westernized world. The imposition of an entirely new form of taxation would not be looked at favorably, so I don't see it happening in an election year.

However, particularly if the Democrats maintain their majority this year, it could happen next year. But I doubt it.
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Wade
  • Wade
  • Veteran Member
14 years ago
This would be so much easier if people just stopped trusting in governments.

I mean, if our neighbor is a spendthrift, do we trust him with our wealth?

Yet we keep going back and trusting the government to figure things out. It's just get this guy out and that guy in.

I just don't understand why we have to trust them just because they're the government.

I mean I'd rather trust GM. At least they've got productive workers to build value. (Even if their cars are halfassed, they're at least half-assed.)

I mean, even GM has had successes. Some Corvettes. The 1968 Chevelle 327. Saturn.

The US government in the last 50 years has had.....please list three domestic "economic" successes that are even close in value to what they cost.

The collateral for American debt is not anything the "government" does. It's the value of productive Americans that the government has been borrowing against.

What's amazing to me is it has taken those foreign lenders so long to figure out that they've been fleeced by the government middleman.

I'd worry if people started to think that the USA people and companies are bad credit risks. But figuring out that the USA government is just a bunch of inept, spendthrift wastrels -- WTF took them so long?
And do not be conformed to this world, but be transformed by the renewing of your mind, that you may prove what is that good and acceptable and perfect will of God.
Romans 12:2 (NKJV)
Wade
  • Wade
  • Veteran Member
14 years ago

This is an excellent question, and one for which I don't have an answer. I think we as a nation probably should go to a VAT model, but I have to think the American people would be highly resistant to that idea. They aren't used to paying upwards of 20% on every purchase, which is what a VAT would entail. The problem is that I think a VAT would be imposed on top of all the taxes we already have, when it should be used as a substitute for some of our more questionable taxes, like property and income taxes.

Though Americans don't realize it, they actually pay some of the lowest taxes anywhere in the Westernized world. The imposition of an entirely new form of taxation would not be looked at favorably, so I don't see it happening in an election year.

However, particularly if the Democrats maintain their majority this year, it could happen next year. But I doubt it.

"Nonstopdrivel" wrote:



Oh yes, and the fact that Americans pay less taxes is merely proof that much of the Western world is even more fucked than we are.
And do not be conformed to this world, but be transformed by the renewing of your mind, that you may prove what is that good and acceptable and perfect will of God.
Romans 12:2 (NKJV)
Formo
14 years ago

This is an excellent question, and one for which I don't have an answer. I think we as a nation probably should go to a VAT model, but I have to think the American people would be highly resistant to that idea. They aren't used to paying upwards of 20% on every purchase, which is what a VAT would entail. The problem is that I think a VAT would be imposed on top of all the taxes we already have, when it should be used as a substitute for some of our more questionable taxes, like property and income taxes.

Though Americans don't realize it, they actually pay some of the lowest taxes anywhere in the Westernized world. The imposition of an entirely new form of taxation would not be looked at favorably, so I don't see it happening in an election year.

However, particularly if the Democrats maintain their majority this year, it could happen next year. But I doubt it.

"Wade" wrote:



Oh yes, and the fact that Americans pay less taxes is merely proof that much of the Western world is even more fucked than we are.

"Nonstopdrivel" wrote:



But they have great healthcare... :roll:
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