“All those foreign sovereigns, for instance, who love to invest trillions of dollars of their reserves in Treasuries — it’s easy to see how they might be rather less in love with that idea at the moment, and how they might start wondering if they shouldn’t just take that money and invest it domestically, instead, or in some other country’s debt or equities.”
But who are these countries that seem to have trillions of dollars of reserves to begin with? Nobody else issues US dollar but the US. Oh yes, these are the countries that incur trillions of dollars of surpluses with the US. And if they continue to incur trillions of dollars of surpluses with the US, they will always have trillions of dollars to invest. Will they invest it domestically in their economies instead? Not unless their people start accepting and circulating US dollars as alternative domestic currency. Have you ever seen an economy that is circulating trillions of US currency in their domestic economy? No. But if they start doing so, then that actually increases the value of US treasuries because if China, for example, starts circulating US dollars domestically, then their citizens will start saving in US treasuries.
Will they invest the US dollar reserves in other countries' debt or equities? What country is going to sell their bonds for US dollars? Where will these 'other countries' put the additional US dollar reserves? US treasuries? And not unless these other countries start circulating trillions of US currency in their domestic economy, who's going to sell their equities for additional US reserves? Again, have you seen a country circulating trillions of US currency in their domestic economy?
No. But if they start doing so, let’s say in Africa where China seems to invest a lot, then that actually increases the value of US treasuries because if Africa, for example, starts circulating US dollars domestically, then their citizens will start saving in US treasuries.
Mind you, I believe this debt ceiling charade will increase the cost of borrowing for the US and for others borrowing in US dollar. But if you were a country with so much dollar reserves, where are you going to put it? In US assets. And if you as that country were to buy some other country’s assets instead, that’s some other country now with excess US reserves. Where will they put it? In US assets. The fact that the manufactured crisis increases the rate for US Treasuries is icing on the cake.
And the answer to the question: What country is going to sell their bonds for US dollars? A country that needs to buy US stuff. The lucky US recipients of this foreign largesse will have to put their proceeds somewhere. Eventually the chain ends when it reaches someone who just wants to save the money. Guess where he puts it.
Additional points:
Ironically, all it takes for the unstoppable increase in US borrowings to be arrested is for China to accept that the hoard it has accumulated all these years is essentially worthless (because the US can just print more of it to pay them), unless it decides to spend it all back in the US. And if China decides to spend their dollars domestically in China, then that ends their peg, and the yuan will then rise vis-a-vis the US dollar.
If ending the peg results in US trade surpluses with China, then there will be less Chinese demand for US treasuries. But the lost demand from China will just be a wash with the less need for borrowings that are due to the deficits from China. But China seems to want to hedge the fall of its dollar holdings by pushing for everyone to shift to the global SDR reserve instead.
I think the Euro is being dragged, German fear of inflation notwithstanding, into the same printing binge as the US dollar. Just look how the EFSF is supposed to prop up the PIIGS. But for how long before the Germans blink and stop the Euro printing (which so far has kept their currency peg with PIIGS) .
5 comments:
exactly. wonderful post and it makes perfect sense rogue.
the only thing I disagree with you about is higher yields. This economy screams deflation at this point in my eyes and yields are only dropping even in light of the default kabuki dance as I like to call it. LOL. Remember Japan. ;)
one interesting thought is that if the economy really does go down and we consume less from china, ostensibly that would mean less exporting from China, which means less US dollars in China's possession, which would then equate to less treasury purchases, which could possibly equate to a rise in yields...but really less buyers doesn't necessarily drop a market...you need to have more sellers than buyers, so that logic probably doesn't hold b/c of that. Just thinking out loud as you can tell here. Cheers! :D
The higher yield comment is a continuation of my comment from a previous Felix post, which I syndicate here.
If US gets a lower rating, it will get priced in the coupon rate, no matter how much the yield to maturity ends up.
If there are less imports from China, i.e., less trade deficit, there would be less need to borrow as well, so it's just a wash with the less treasury purchases from China.
got it.
"so it's just a wash with the less treasury purchases from China."
so you are saying that yields would likely remain the same and not move. Is that right?
Mario, the lost demand from China (if there will be less trade deficits with them) will wash out with less need for borrowings that are due to the deficits from china.
I wouldn't be able to say if the yield will be the same. It is after all determined by other factors like demand from other buyers, Fed another quantitative easing, and a possible ratings downgrade for the US.
A ratings downgrade will increase coupon rates for the US, hence increase cost for the US in noinal terms, though the resulting yield will again be largely determined by many factors.
"A ratings downgrade will increase coupon rates for the US"
I still don't know if that is necessarily true. I keep hearing that when Japan was downgraded their rates kept falling. I haven't looked at the data myself, but I take their word for it.
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