American Debt Losing Its Appeal?

By Alex Parets

With the interest in China over the past week or so on this blog, this excerpt from yesterday's NY Times caught my eye:

The declining Chinese appetite for United States debt, apparent in a series of hints from Chinese policy makers over the last two weeks, with official statistics due for release in the next few days, comes at an inconvenient time.

On Tuesday, President-elect Barack Obama predicted the possibility of trillion-dollar deficits “for years to come,” even after an $800 billion stimulus package. Normally, China would be the most avid taker of the debt required to pay for those deficits, mainly short-term Treasuries, which are government i.o.u.’s.

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.

Now this development is not that big of a deal in the short run, as demand for Treasuries is at an all-time high and yields on everything from 4-week to 3-month Treasuries have gone negative over the past month. So a short run Chinese pullback from purchasing U.S. debt may very well be usurped by increasing demand and a strong market for the extremely safe asset.

However, in the medium term (say 12-18 months from now), this development may indeed hurt the United States. As China pulls back (forecasts show that China’s foreign reserves will increase by $177 billion this year, down sharply from an estimated $415 billion last year) and continues to pull back, and the markets rebound in the medium term, demand will shift from the debt markets to equities or whatever new instruments are in vogue at that time. This would drive up the interest rates that investors would demand for Treasuries, thus making it more expensive for the U.S. to borrow. Interesting development to watch for over the next 12-36 months.

Comments

[tdillian:]

"extremely safe asset"

nope.. don't consider US tresuries an "extremely safe asset" anymore

this is the next bubble.. america is broke and bankcrupt.. why would anyone want to lend money to a country that is broke to the point where they will not see return of their money...

Jan 09 08:50 AM

[secmaven:]

If the Fed buys the debt the interest rate can be set at whatever the buyer chooses. Higher interest rates and a collapse of the US debt bubble are not an automatic result of the issuance of more debt.

And what will be the result of the monetization of Obama's debt?

Japan monetized trillions of yen government debt in the last five years and its currency is the strongest in the world. Why? Because Japan's economy is productive and operates under a rule of law. its currency, borrowed at zero interest rate, has become an engine of finance, providing the liquidity needed to facilitate much economic activity. If the world perceives our economy as strong and operating under a rule of law, ie. no Patriot Act arrests in the night and tax the wealthy out of existence schemes, etc. there is no reason monetization of our debt cannot work the same way it has in Japan. Obama promises to bring both discipline and creativity to the financial management of this country with much of the newly created money entering the system from the bottom up. This is a prescription for success.

Jan 09 11:41 AM

[Moon Kil Woong:]

No one is pleased with American debt but everyone wants internationally tradable cash.

China may not like what the US is doing but 1) their country's demand can't support even 50% of their output so them must keep selling to the US if they want to keep their economy from collapsing 2) their currency is falsely suppressed so if they want to start using it to buy goods overseas they will have to let it float more freely and they will not benefit as much from falsely lowering their currency if they use it to buy stuff like oil and 3) the odds the rest of the world creates an alternative cash regime for International trade is 0% right now no matter how spend crazy the US gets. If anything it will be hard to get any country to agree on anything in 2009 and I wouldn't be surprised if international strife, revolutions, and wars start popping up (a very real and disastrous symptom of a global downturn).

The US is a bastion of political stability if that happens. I don't see any US revolution even if the dow hits 3,000 besides maybe Alaska and Sarah Palin's husband's independence league grumbling about not getting a fair shake on their oil anymore.

Jan 09 11:49 AM

[huangthomas:]

The major reason for Chinese to purchase less American treasuries and other US$ denominated debt instrument is that China has less money available to them. The money come from two sources. The first and the major source is trade surplus. As Chinese export is hurt by the current financial crisis, reduction in purchase of US treasuries is a natural consequence. The second source of Chinese money is interest rate arbitrage. The Chinese central bank (People's Bank of China) require 20% of the bank deposit be transferred to the central bank, which pay 2% interest. The central bank use the fund to purchase US debt instrument which used to pay 3 to 5% interest. As US interest rate drops, there is much less incentive to purchase the US debt instrument for interest rate arbitrage.

Jan 09 12:10 PM

[Conan the B...:]

The USD has risen from a low of 71 to a high of 88. Down to 79 or so and back up to 84. The Yuan has tracked the dollar within a couple of %.

That means that the Yuan has appreciated along with the USD. Their exports to the rest of the world are cutting into their profits.

Devaluing the dollar without creating further appreciation of their own currency will be an interesting exercise.

Meanwhile, the Largest holder of US Debt externally is Saudi Arabia with an estimated $2.5 Trillion. They have been at it much longer than China.

Jan 09 12:48 PM

[Conan the B...:]

Constructe: China exports only about 22% of its total production to the US. Since 2005, the Yuan has appreciated about 15% against the USD.

The US government wants the Yuan to appreciate more but the Chinese have already taken a big hit. The Yuan has risen with the Dollar in the past 5 months. Their exports to the rest of the world are hurting.

Jan 09 12:58 PM

[Asbytec:]

Two camps here: China will not buy and China will buy. Probably both are right. I suspect China will cut back due to necessity, but has an interest in supporting the US consumer. So, it will probably do what it can...albeit less than before. How's that for straddling the fence? :)

As for the yuan, it'll probably be business as usual. They might even devalue some more, beggar thy neighbor. I mean, inflation is on the fall globally. They can afford it.

Jan 09 01:33 PM

[notsosmart:]

would you buy from a country that flooded the world with phony rated AAA worthless paper? short term perhaps to save your own skin but the world now knows our ponzi.

Jan 09 02:08 PM

[huangthomas:]

We have been doing it since the end of WW II. We print the paper money and buy up the world. European saw it, but have no means to deal with it. Charles de Gaulle was the first one to take action. He shipped tons of paper dollars and asking for gold at $35 an oz. That scared Richard Nixon to dissociate dollar from gold in 1972. Now American currency is only a faith-based commodities.


On Jan 09 02:08 PM notsosmart wrote:

> would you buy from a country that flooded the world with phony rated
> AAA worthless paper? short term perhaps to save your own skin but
> the world now knows our ponzi.

Jan 09 03:07 PM

[Conan the B...:]

The Yuan has to devalue by about 15% just to go back to what it was 5 months ago and by much more against some of its neighbors, it has been moving with the dollar.

The only currency appreciating against both of them is the Yen.

To me it means, problems on the export side for the US, Japan and China to the rest of the world and the rest of the world ex Japan will have the ability to undercut both the US and Japan in trade with China.

I just wish that our Government would do something really stupid that would make our goods more competitive internationally. I was hoping that the Bernanke announcement of new Fed printing presses would do the trick, when the USD stopped going back down. I had to switch sides on Gold.

Jan 10 01:42 AM

[Shannon Melton:]

Paco Ahlgren agrees:


experienceiseverything...

Jan 10 05:17 PM