What Happens When Demand for US Debt Dries Up?
Over a year ago, I wrote about China threatening to stop buying US Treasuries.
According to an article in the New York Times, it now looks like China is losing it’s appetite for US debt :
In the last five years, China has spent as much as one-seventh of its entire economic output buying foreign debt, mostly American. In September, it surpassed Japan as the largest overseas holder of Treasuries.
But now Beijing is seeking to pay for its own $600 billion stimulus – just as tax revenue is falling sharply as the Chinese economy slows. Regulators have ordered banks to lend more money to small and medium-size enterprises, many of which are struggling with lower exports, and to local governments to build new roads and other projects.
All the key drivers of China’s Treasury purchases are disappearing – there’s a waning appetite for dollars and a waning appetite for Treasuries, and that complicates the outlook for interest rates, said Ben Simpfendorfer, an economist in the Hong Kong office of the Royal Bank of Scotland.
By itself, this is a concern for our government. Recently, it sold billions of 3 year treasuries at a 1.2% yield! But when the demand for treasuries eventually dries up, yield should start jumping higher. But to make matters worse, the government will start a slew of public works projects and bailouts, for which we will have to borrow even more money. At some point the demand will simply fall short of the supply.
Here’s an interesting note by James Quinn on investmentrarities.com:
As the politicians scurry to “save” capitalism through the use of communist measures, more Americans are becoming disheartened. The definition of communism according to Webster’s is:
A system in which goods are owned in common and are available to all as needed.
George Bush, Henry Paulson and Ben Bernanke have decided to seize money from the vast majority of Americans who lived within their means, utilized debt sparingly, and worked hard to get ahead, and give it to the most appalling failures in our society. They have shoveled billions to banks that operated their businesses like gambling parlors. They have shoveled hundreds of millions to people who bought houses with no money down, interest only mortgages and fraudulent loan applications. They are now rewarding automakers who made the wrong vehicles, pay 30,000 workers per year to not work, and have only been able to “sell” cars by giving them away with 0% financing to any schmuck who could sign on the dotted line. These acts fit the definition of communism. We are now more communist than China.
So what are the repercussions of our monetary policy? According to Chuck Butler of Everbank.com (which I highly recommend):
“US government will have to ratchet the yield on these bonds up so high to attract investors… OR… Allow a general debasing of the dollar to allow those purchases of Treasuries to be made at a discounted clearing price.”
A lot of people will disagree, but during these economic times, we’ll see inflation and not deflation. And gold will continue to be a store of value and a hedge against inflation. Even though its quite popular to bash gold and call it a lousy investment, the fact remains that gold has been one of the best performing assets during the past decade. I’ve been buying gold coins since 2005 and while the price of gold is up around 50% since then, the premiums on gold and silver coins has increased more than twice that. (Premium is what you pay over the spot price of gold). This shows an increasing demand for gold coins.
Gold and silver coins will be the next bubble! The bubble has barely started and should take 2-3 years to play out.
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January 10th, 2009 at 8:52 am
There is a more fundamental reason for China decreasing its purchases of American Treasuries, all political bluster aside: Americans are buying fewer Chinese goods, so there is less foreign exchange to reinvest in American dollars. China doesn’t want it this way, but that is the repercussion of the American consumer recession.
I don’t buy for a second that China is less interested in buying US Treasuries, anymore than I would take the same threat from Japan, Taiwan, Korea, India, Venezuela or Russia seriously. All the rest of the world (net exporters, at least) depend on the purchase of their goods by Americans for the strength and growth of their own economies. When they export to America, they receive US dollars in return. If they want their own currency to remain competitive against the dollar (to not appreciate), they must hold those dollars, most often in the form of Treasuries.
That is the reality. All the rest is smoke.
January 10th, 2009 at 1:31 pm
I don’t buy into the whole inflation scam. The FED is not printing money they are lending it to banks, which hoard the cash, so at the end of the day the cash is not really used.
If a depression occurs, we are going to see deflation as most asset values decrease ( not just stocks but goods as well )as there is less demand for goods and svcs
January 10th, 2009 at 2:10 pm
Exactly right, DGI. Not only are assets being exchanged for capital, under programs like TARP, resulting in a net wash in terms of broadest measures of money supply, but the “velocity” in the turn-over of that exchanged capital is very low right now, so there is no “multiplier effect” to amplify demand.
Let us remember the fundamental definition of inflation is “too much money chasing too few goods”. It is hard to understand how with no one spending any money, there is the excess demand required to create inflation. And in markets like residential real estate, there is a huge over supply of houses, so goods are “too many”, not “too few”, thereby, this portion of the economy is actually contracting offsetting (thwarting) the efforts to “reflate” the economy.
I do agree with “Living”, that dividends are a good value strategy right here. I am reinvesting mine in the stocks that generate those dividends, buying undervalued stocks at cheap prices with house money. And it is possible, that somewhere down the road, once the economy has been “reinflated” and money has been created to replace that which has been destroyed in this year of deflation, that the central bank may not get off the pedal quick enough and there may be some overshoot.
For that reason, I am working the reinvested dividend play in energy and materials stocks that will benefit from a recovering economy, increased demand from a growing economy and a government sponsored infrastructure program. This MAY result in an eventual period of MILD inflation. I am looking for a period like the mid 70s with 5-7% inflation. I think the Fed will take that over deflation as it is much easier to correct, eventually, with higher interest rates. But I think the calls for either a prolonged deflation or a period of hyperinflation, are both very wrong and cherry pick history wtih assymetrical precedents.
January 11th, 2009 at 12:17 pm
Debate about inflation/deflation apart.. why not buy ETFs like GLD,SLV rather than gold silver coins, if one wants exposure to these markets?
January 11th, 2009 at 1:08 pm
very good question.
why should you buy gold/silver coins?
as the demand for gold/silver increases, the premiums on the coins will start widening. its already grown in the past 2 years after being almost nothing for over a decade. I paid $20 over spot for Australian Lunar gold coins back in 2006.
Since then, they attained collector status and fetch a bit more than that. But even bullion coins like the Krugerrand will demand a premium of at least $50 over the spot price of gold.
Also, if confiscation ever comes back to the US (you never know, it just might – we’ve already had a historical precedent) its better to have non-confiscatory collectible coins rather than ETFs or bullion.
January 13th, 2009 at 9:07 am
HP – part of the attraction of owning gold and silver, is the fact that you own something with intrinsic value, something solid, something substantial. Owning a metals ETF may give you exposure to price ups and downs, but certainly doesn’t give you that reassuring feeling that only real precious metals in your hand can.
Many metals owners want to isolate some of their wealth from the electronic / paper system that we all live in. If that system crashes – what would your ETF shares be worth? Not a whole lot. Hence the desire for real metals.
January 14th, 2009 at 2:28 am
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January 15th, 2009 at 10:00 pm
I think that deflation is a much greater problem than inflation. T-bills are selling at extremely low interest rates. An inflationary environment would be a good problem because it would mean our economy is growing. The Treasury may be pumping money into our economy but no one is spending.
March 3rd, 2009 at 1:21 pm
What do I think to the Royal bank of scotland? RBS boss Fred goodwin should be stripped of his pension. If they pay him a profit related percentage he will get minus figures. Taking away his pension is the best option.