U.S. Treasuries: China's Dilemma

The U.S. manufactures trillions of dollar bills (IOUs) and exports them all over the world in exchange for the goods from foreign countries. Our dollar is a world currency and is accepted for payment everywhere (thanks to the dollar's credibility).

The foreign countries such as China, Japan, etc. sell much more goods and services to the U.S. than they buy from us so they take the surplus dollars (IOUs) and just pile them into their banks. Their banks cannot just leave them lying around so they invest them in American Treasuries or (Wall Street) corporate stocks and bonds so they can earn some interest. The foreign banks have so many American IOUs to invest compared to the Treasury bonds available that they drive down the interest rates on these bonds to very low levels. (When the sub primes went bust in 2008 there was a run on Treasuries that drove the interest rates down to near zero.) This makes the interest burden for America comparatively cheap even though there are trillions of these American IOUs spread out all over the world.

The Chinese are in a dilemma. What can they do with all this American debt that they own? Well, they can buy American Treasuries or goods, or corporate stocks and bonds or real estate or they can sit back and collect the interest on the Treasuries (which is now very low) or they can redeem the bonds.

They threaten to sell their U.S Treasuries if we are not good. If they sell their U.S. Treasuries - who are they going to sell them to? Our government doesn't have to buy them back until they mature. When they mature our government will redeem them with our dollars (IOUs) so their banks will again be full of these non-interest paying American IOU dollars - so they immediately have to reinvest them in U.S. Treasuries.

To punish us for what they claim to be "bad trade practices" the Chinese just canceled a trip to buy soybeans and wheat. SO WHAT? The wheat and soybean market dropped BUT they still have 1.5 billion people to feed and they're loaded with U.S. dollars, so they will be back. (It might be a good time to invest in those commodities?)

What a dilemma for the foreigners! The foreigners lost their shirts investing in the American real estate market in the 1980s and now Wall Street wiped out trillions dollars of foreign debt in the latest stock market crash and subprime real estate bond fiasco. (Iceland lost so much money the country nearly went bankrupt.) Maybe the best thing the foreigners could do is just buy American goods. At least they will get something tangible for their money.

The best thing that we in America can do is to buy as many foreign goods as we can and pay for them with dollars (IOUs). By doing this we can keep the demand for our Treasury bonds (exchanging dollars for Treasury bonds) as high as possible, thereby keeping the interest rates extremely low. This keeps the whole world busy manufacturing and selling their goods to America and it also keeps America busy making goods and selling to the "dollar rich" foreign countries. When America stops buying the whole world goes into a depression! This is why protectionism is so bad. This is happening right now; there is a lot of world wide unrest due to the American slow down in purchasing foreign goods.

A Treasury report this past week showed net foreign purchases of U.S. securities fell to the lowest level in five years, raising concern about the U.S.'s ability to finance the deficit in its current account. This is because Americans are not buying foreign goods fast enough. Therefore the foreigners do not have enough dollars to purchase the U.S. securities; the demand for bonds is down so the interest rates will rise. BAD. Perhaps President Obama should make it part of his stimulus package to encourage Americans to buy foreign imported goods - stimulate trade - keep that economic river going full blast. This will get the American factories going again.

The main thing for America to do, as I see it, is to try to limit the amount of bonds available compared to the foreign demand for them. One way to do this is start paying off our tremendous national debt. This reduces the supply of both U.S. dollars and bonds, keeping the supply of bonds lower and Treasury interest rates as low as possible and the dollar strong.

Comments

[Steven Hansen:]

you cannot say seeking alpha does not provide a coliape of opinion. now a call to buy imported crap.

Peter Morici argued a few days ago that it was the trade deficit itself which caused this depression.

i do agree that there is not much china can do with its dollars. this is why trade balance is in the best interests of the importing and exporting countries.

Mar 16 05:45 AM

[ArkansasAngie:]

"The main thing for America to do, as I see it, is to try to limit the amount of bonds available compared to the foreign demand for them. One way to do this is start paying off our tremendous national debt. This reduces the supply of both U.S. dollars and bonds, keeping the supply of bonds lower and Treasury interest rates as low as possible and the dollar strong."

Let's see ... we can pay off our "tremendous national debt" by printing more money or ... Americans could save.

But if Americans save then that means they aren't buying imports.

Mar 16 06:32 AM

[User 143167:]

China has to export its good because there is no enough domestic demand. However, that is not because they don't have the people who will demand those goods. It is only because its inequality between rich and poor is too large.
US demand provides an easy strategy for the Chinese government to meet their authority and self-interest(corrupti... one party system) while keeping the economy and labor market on fast growth. In that sense, the Americans are the best friends and offere greatest help to those corrupted and greedy political cadres in China, who ironically the US always accused in its public media.
If China changes into a system with more balanced income distribution among its citizens, China can surely consume most of what it produces and thus don't bother to export them to the US. That will change the whole game of the world. Therefore, for Americans, you'd better hope China government is as ruthless and corrupted as before.

Mar 16 06:33 AM

[y3115y:]

During a starvation period in China, there was no grains, the King said, "Why don't they eat meat?"

You want us to pay off our debt? How about our people on welfare to pay more taxes?

China is a developing country, people in any developing country, like Japan in the 70s, Taiwan in the 80s, they save more. China now is doing the same. They would save less when they became developed like us.

Mar 16 08:24 AM

[huangjin:]

He's exactly right. If the U.S. government stops creating Treasury bonds, foreign holders of dollars have three (main) options: invest in U.S. stocks and bonds, buy American goods, or sell their dollars.

The U.S. Treasury is crowding out U.S. business and investment.

Mar 16 08:58 AM

[huangjin:]

Also, the U.S. doesn't have to pay off the debt, just stop making it bigger.

Mar 16 08:59 AM

[Fabien Hug:]

If China would let its currency float, it would already have lost half of its investment in TBonds. They don't have to buy US goods with their dollars, they can buy commodities. It is seems that they are doing so and I would do the same. One can always find good use to oil, copper and other "stuff".

Mar 16 09:02 AM

[kelm:]

There is a presumption that a foreign nation owning dollars can only buy things from the US. That is incorrect. Anything that is denominated in dollars or indeed, any seller of anything who is willing to take dollars can take those dollars off their hands.

Oil for example is denominated in dollars yet it is not something China buys from the US. Ditto with gold. If Brazil is willing to sell soybeans and denominate them in dollars China can oblige. If a mining company wants to sell an equity stake to China in dollars they can do so.

Increasingly we are seeing China take their foreign reserves and secure hard assets with them. They have made financial loans worth 10s of billions to Russia and Brazil in exchange for oil. Likely they used dollars for the transaction.

Mar 16 09:16 AM

[Lonestar1:]

It's so sad to read this article. This is like a bad boy being caught in the middle of his misdeed, and claims he will get worse. What's the chance this boy will prosper? Zero, because evrybody will abandone him.

Mar 16 10:36 AM

[Tony Daltorio:]

The author completely misses one main point - what will China do in the future? The US desperately needs China to continue purchasing the massive amount of Treasuries we will be selling.

Most likely going forward, China will purchase much less US Treasuries and purchase real assets. China has already begun that process and is buying oil, metals,food,etc.

Mar 16 10:57 AM

[Billy Gee:]

The only thing this author got correct is for the U.S. reducing its debt. The rest should have been posted on April 1st.

Mar 16 11:35 AM

[henarl:]

Our problem was that we were buying disposable crap from China and disposable energy (oil) from the middle east and now we don't have anything to show for it except a big party hangover and a huge debt. And we should go back to partying again? I don't think so!

China is probably not as dumb as we were. They will likely spend their dollars on energy and materials to build up their infrastructure and also purchase our companies and real estate for 50 cents on the dollar, rather than our disposable products which are higher priced than theirs

Mar 16 12:18 PM

[ArtfulDodger:]

kelm:

Thank you for that comment. Very good points that the author (and most others) have overlooked.

Indeed, China is investing from SA to BR, and they are using dollars.

Mar 16 02:27 PM

[@TexasER:]

China participated in the drunken party too. They tried to hoard wealth in US dollars, keeping their industrialized citizens in poverty.

And because they chose not to invest in building their domestic economy, they now see their hoard at risk and find themselves out of work at the same time.

Let them dump treasuries and watch the Yuan skyrocket.

I double-dog-dare them.

Mar 16 04:05 PM

[Mad Hedge F...:]

China definitely has a problem here. Chinese president Hu Jintao has expressed “concern” about the safety of his country’s $696 billion investment in US Treasury bonds. What he is not telling you is that he is even more “concerned” about the hundreds of billions of Fannie Mae, Freddie Mac, GMAC, and other agency debt, which are either now untradeable, or have gone into the toilet. And “concerned” he should be. Not only is some of the paper China owns now worthless, there is a 50% devaluation of the dollar in the cards which is the guaranteed result of current US government printing press policies. One of the great luxuries of running a dictatorship is that you can skip mark-to-market accounting. The government entities that own this garbage are carrying it on their books at par, because they intend to hold it to maturity. If China used mark-to-market they would have plunged into another civil war by now. Expect to hear more “concerns” from Japan, Singapore, and the sovereign wealth funds that are in the same boat.

Mar 16 04:39 PM

[Dissenter:]

You have to ask the right question. And that question is why hasn't China taken more steps to develop their domestic economy and increase consumption? The answer is that they can't afford to. It would be infinitely harder to keep their citizens in check once their economic status rises and they had a taste of the good life. How does a country sustain that prosperity for a billion people once its let out of the bag? They lack commmodities, are overpopulated, and overpolluted.

Right now the Chinese are still buying our debt which will lead to a further devaluation of the yuan to increase exports and create jobs. My question is if the Chinese decided to appreciate the yuan what will that do to China's growth and what will a rise in the yuan mean for jobs in China?

Mar 16 08:57 PM

[newamericanow:]

Read the article on the Link

May 31 08:44 PM