Are Uncle Sam's Creditors Heading Towards the Exits?

In 2008 the credit crisis spread around the world like a virus. We saw individuals, companies and small countries go to the wall. Will 2009 be the year when U.S. creditors refuse to expose themselves to an ever increasing risk of default in order to protect their own economies? There are growing signs of hesitation and fear on behalf of those who would lend Uncle Sam the funds to finance yet another "stimulus" plan. No small wonder as the U.S. is flat broke and up to its eyes in unpaid debt as it is. With inflationary fears added to the mix as trillions of dollars emerge in to the U.S. economy over 2009 and trillions already thrown in to the bottomless pit of the financial sector, China and Japan are getting nervous.

Japan's utter panic was summed up by Akio Mikuni, President of the ratings company Mikuni & Co. when he suggested that "Japan should write-off its holdings of Treasuries because the U.S. government will struggle to finance increasing debt levels needed to dig the economy out of recession." For good measure, "The dollar may lose as much as 40 percent of its value to 50 yen or 60 yen from the current spot rate of 90.40 today in Tokyo unless Japan takes drastic measures to help bail out the U.S. economy."

China's Central bank governor Zhou Xiaochuan announced that it will allow the yuan to be used for settlement between Guangdong Province and the Yangtze River Delta and exporters in the Guangxi Zhuang Autonomous Region and Yunnan Province in southwestern China will be allowed to use the yuan to settle trade payments with members of the Association of Southeast Asian Nations. His tongue-in-cheek explanation?

The US dollar is unlikely to be stable next year and later. And the likelihood of the United States issuing more money in the near future adds to the depreciation risk in US-dollar-denominated assets and trade settlements. (Source)

A previous report describing China's proposed sevenfold increase in gold reserves is also indicative of its gradual pullback from the doomed dollar. Gold has been slowly rising as investors, previously struck rigid with fear, are now taking a breath and looking at real value. The old adage of gold being a safe haven is coming back into play and no amount of gold price manipulation on the exchange is going to change that. With China's announcement of its intention to build up its reserves to 4000 tons, we can expect other Treasury Note holders to be thinking along the same lines. This can only lead to a bullish gold market and a collapsing market for Treasuries. Treasury note doomsayers are a growing community amongst which we can count former Bank of England policymaker, Willem Buiter, who summed up his position thus:

Even the most hard-nosed, Guantanomo Bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed.

And Barrons is announcing a coming Treasury Bubble Pop:

Treasuries offer little or no margin of safety if the economy unexpectedly strengthens in 2009, or the dollar weakens significantly, or inflation shows signs of reaccelerating.

Forbes is predicting China's future diversification of its reserves as Treasury Bills become more of a liability:

Washington's issuance of mountains of debt to bail out the U.S. economy will only make T-bills less rewarding, putting the dollar's future strength in question. Various economists are saying it will be in China's interest to diversify in the near future.

We can discount the unexpected strengthening of the economy in 2009, but inflation has to rise once those trillions are in the playing field and the dollar will be toast. Bonds, yielding next to nothing, don't exactly present an attractive investment opportunity. The only reason Treasuries have been so attractive up to now was that they were presumed to be a safer harbor than equities, commodities or cash.

No amount of "stimulus" plans can fool all the people all the time. After the initial massacre, investors are taking a moment of reflection and taking a more long term approach. We are now in an era of survival and protectionism rules the day.

Comments

[Tradememe:]

China and Japan have a bigger problem. Their main customer, the US consumer, is no longer buying. So, until both countries get their internal consumption up to speed, I doubt they will take any big risk currency-wise.

Jan 22 08:27 AM

[know nothing:]

Sooner or later the world will cut their losses. Who wants to keep betting on a loser, no matter how talented someone is sooner or latter they grow old,and lose their ability they once had, Mohamid Ali, Mike Tyson, Babe Ruth, and The United States of America, were considered to be the best of their time! But to think you can never be replaced,or noone can beat you, is the biggest lie you will ever tell yourself. Don't you believe it!

Jan 22 09:52 AM

[User 298860:]

Buy HSBC

Jan 22 10:14 AM

[Chris B:]

I like the Barron's quote:

"Treasuries offer little or no margin of safety if the economy unexpectedly strengthens in 2009, or the dollar weakens significantly, or inflation shows signs of reaccelerating."

As they illustrate, treasuries can hold their value in exactly one scenario: a deflationary depression in which the dollar also stays valuable vs. other currencies. That's why I bought TBT and PST. We're not following the policies of the early 1930's anymore and I think unprecedented money supply expansion will kill deflation. Regardless of what happens to the economy afterwards, TBT and PST will pay off.

Jan 22 10:20 AM

[Chris B:]

If foreign investors stop buying treasuries, the government will resort to money-printing to fund itself. This would devalue the currency, so this possibility suggests that US and foreign investors should be diversifying out of the dollar.

But what currency should we go into? The British pound is even worse off, and Willem Buiter has suggested that it could go the route of Iceland's currency. Both the Euro and the Yen seem unattractive due to debt/GDP ratios that are far beyond even the US's levels and demographic graying. The Canadian and Australian dollars seem to track commodity prices more than fiscal policy or obtainable yields, so you might as well be buying commodities. The Chinese yuan is issued by a communist export country that has an interest in keeping its value down. India has chronic inflation. Commodities such as precious metals and oil are volatile gambles on future inflationary sentiments, and don't really fit the definition of a safer investment than the USD as their fluctuations are far greater than the dollar's. What's left?

Jan 22 10:37 AM

[LCACM:]

The main reason the US economy finds itself in such poor health is the Chinese / Asian dumping of goods on the US market. As long as this dumping continues unabated, the US economy will be unable to revover. So everything depends on whether Obama takes a pragmatic approach and takes steps to save the US economy.

Jan 22 10:47 AM

[fran:]

what is the purpose of money? an exhange convenience for bartering for the things needed for survival or consumption. perhaps the answer you seek is not predictable and may be different at differing times of history. has this been true thru history? the dollar has been choice in world commerce a brief???[how long?]. is there a required timespan?


On Jan 22 10:37 AM Chris B wrote:

> If foreign investors stop buying treasuries, the government will
> resort to money-printing to fund itself. This would devalue the currency,
> so this possibility suggests that US and foreign investors should
> be diversifying out of the dollar.
>
> But what currency should we go into? The British pound is even worse
> off, and Willem Buiter has suggested that it could go the route of
> Iceland's currency. Both the Euro and the Yen seem unattractive due
> to debt/GDP ratios that are far beyond even the US's levels and demographic
> graying. The Canadian and Australian dollars seem to track commodity
> prices more than fiscal policy or obtainable yields, so you might
> as well be buying commodities. The Chinese yuan is issued by a communist
> export country that has an interest in keeping its value down. India
> has chronic inflation. Commodities such as precious metals and oil
> are volatile gambles on future inflationary sentiments, and don't
> really fit the definition of a safer investment than the USD as their
> fluctuations are far greater than the dollar's. What's left?

Jan 22 12:14 PM

[ezrasfund:]

Swiss Franc


On Jan 22 10:37 AM Chris B wrote:

> If foreign investors stop buying treasuries, the government will
> resort to money-printing to fund itself. This would devalue the
> currency, so this possibility suggests that US and foreign investors
> should be diversifying out of the dollar.
>
> But what currency should we go into? The British pound is even worse
> off, and Willem Buiter has suggested that it could go the route of
> Iceland's currency. Both the Euro and the Yen seem unattractive
> due to debt/GDP ratios that are far beyond even the US's levels and
> demographic graying. The Canadian and Australian dollars seem to
> track commodity prices more than fiscal policy or obtainable yields,
> so you might as well be buying commodities. The Chinese yuan is
> issued by a communist export country that has an interest in keeping
> its value down. India has chronic inflation. Commodities such as
> precious metals and oil are volatile gambles on future inflationary
> sentiments, and don't really fit the definition of a safer investment
> than the USD as their fluctuations are far greater than the dollar's.
> What's left?

Jan 22 12:29 PM

[IronCity:]

To Chris B

I agree with: “…treasuries can hold their value in exactly one scenario: a deflationary depression in which the dollar also stays valuable vs. other currencies” and with “I think unprecedented money supply expansion will kill deflation.” (I feel the same) .

But I can’t understand why “…TBT and PST will pay off.” If “deflationary depression in which the dollar also stays valuable vs. other currencies”.

Please can you make it clear to me. Thank you!

Jan 22 12:48 PM

[Chris B:]

If anything other than continued Japanese-style deflationary recession occurs, treasuries will lose value. Here are some scenarios that would prompt people to sell their near-zero-yield treasuries at a loss.

stagflation
recovery w/ high inflation
recovery without high inflation
rates are increased from near zero
USD collapses in international value

TBT and PST are short US treasuries, so their dollar value should increase if any of the above scenarios occur.


On Jan 22 12:48 PM IronCity wrote:

> To Chris B
>
> I agree with: “…treasuries can hold their value in exactly one scenario:
> a deflationary depression in which the dollar also stays valuable
> vs. other currencies” and with “I think unprecedented money supply
> expansion will kill deflation.” (I feel the same) .
>
> But I can’t understand why “…TBT and PST will pay off.” If “deflationary
> depression in which the dollar also stays valuable vs. other currencies”.
>
>
> Please can you make it clear to me. Thank you!
>

Jan 22 01:44 PM

[Carl Spackler:]

If you are worried that the dollar will become worthless and are looking for an investment vehicle to maintain your buying power, virtually all the currencies are bad bets. Every nation on the earth has a similiar look, feel, and reality to it - ever increasing debt and extremely weak economy. If the dollar, Euro, and Yen tanks, then you have to seek real assets - Oil, Gold, and yes real estate. Ironically, the worst investment you can make now (real estate) may end up being the best in a few years. If you have a fixed rate loan at 5% and we see massive devaluation, you will be paying for a hard asset with future cheap dollars. The average workers pay in 8 years may be $40,000 per month, so you could potentially pay off your current home (or other real estate holdings) with just a few months pay. The strangest scenario is being set up whereby those who could keep their houses may end up with the steal of the century.

The potential for dollar devaluation is enormous, and all the hard assets will do great, but during Mexico's devaluation in the 80's, real estate was the best return. I am about as anti-real estate as anyone you could find, but even I recognize that this is a potential home run setup. Another good play is short Treasuries, long Oil, or long Gold. I would however stay away from all currencies - even the Yen. Japan had their first trade deficit last month due to falling exports, so now even they are running in the red.

Jan 22 04:40 PM

[IronCity:]

To Chris B.
Thank you for your clarification. I have followed some of your comments and find it excellent.

Jan 23 10:15 AM

[notsosmart:]

it may also be saturation.most in the usa have too much stuff.your car,if maintained & not alemon, can last a long time with lots of mileage.what good is gold if you are hungry or thirsty? if all have a bit of gold who's interested?pay off your house,car,credit cards & save the interest.maybe the dumb-dumbs are waking up.it may be too late.

Jan 23 10:42 AM

[Guero:]

So "the U.S. is flat broke and up to its eyes in unpaid debt?" Really? How did that happen?

As recently as 2000 the US was running budget surpluses and was retiring debt. The 30 yr was even phased out.

So what happened since then? I'm sure it will come to me...

Jan 23 11:40 AM

[notsosmart:]

"mission accomplished" happened.

Jan 23 04:52 PM

[DOK FROTH:]

Google - "The Money Masters", a 3.5 hour video I found very interesting.
Explains the history of fractional reserve banking in Europe and USA.

Jan 23 11:32 PM

[applesauce:]

Sounds like you are suggesting protectionism, I pray we do not fall into the us vs. them problem that will deepen the global downturn.


On Jan 22 10:47 AM LCACM wrote:

> The main reason the US economy finds itself in such poor health is
> the Chinese / Asian dumping of goods on the US market. As long as
> this dumping continues unabated, the US economy will be unable to
> revover. So everything depends on whether Obama takes a pragmatic
> approach and takes steps to save the US economy.

Jan 25 02:02 PM