China Dumping Long-Term Bonds, Concerned About U.S. Inflation 26 comments
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There has been much concern as of late about the decline of the U.S. Dollar. One camp believes that China, fearful of the recent massive increase in the U.S. deficit, is dumping the U.S. Dollar and will cause the Dollar to crash. The other camp believes that China is trapped into supporting the U.S. Dollar in order to keep its own currency, the yuan, cheap and its exports competitive. This camp believes that China has no choice but to keep buying the long-term bonds issued by the U.S. Treasury and GSEs in order to prop-up the dollar.
Then there is what China is ACTUALLY doing...
China isn't dumping the dollar or dollar assets, it is recycling the money from the sale of long-term bonds and parking it into short-term U.S. Treasury notes. This is a concern, because these notes are easier for China to "dump" should inflation pick up in the U.S.
Keith Bradsher of the The NY Times recently wrote an interesting piece about China's growing concern over the U.S.'s inflationary policies.
China has been exchanging one dollar-denominated asset for another — selling the debt of government-sponsored enterprises like Fannie Mae and Freddie Mac in a hurry to buy Treasuries. While this has been clear for months, new data shows that China is also trading long-term Treasuries for short-term notes, highlighting Beijing’s concerns that inflation will erode the dollar’s value in the long run as America amasses record debt.
According to Senior Chinese economic policy maker, Xu Lin, China is committed to maintaining the dollar peg, for now, and continues to support the dollar by sterilizing trade surpluses. Due to the global recession and reduced demand for chinese exports, China has had to do a lot less sterilizing lately.
"China is strongly opposed to any significant appreciation or depreciation of its currency, Mr. Xu said at a press conference. But if international investors conclude that the Chinese economy has stabilized ahead of economies elsewhere, they may start pumping more money into the Chinese economy," he said.
For how long this continues is anyone's guess, as the NY Times article says:
The big question now for policy makers and economists alike lies in whether the Chinese government’s purchases of American securities will rise or fall in the coming months.
China is seeking to change the ways that it sterilizes the surplus of dollars that it receives from the U.S. Instead of the Chinese government buying up excess dollars, and investing them in U.S. Treasuries and the bonds of GSEs, China is
a) encouraging private Chinese companies to use dollars to make investments (thus recycling the dollars) and...
b) Using the dollars to stockpile commodities, such as iron ore, crude oil and grain.
The bottom line to all of this is that China is rightly worried about inflation in the U.S. and the impact that inflation would have on China's holdings of long-term U.S. bonds. While China still seems committed to the dollar peg, China is diversifying its foreign exchange reserves by using it's surplus dollars to purchase real assets that are inflation resistant such as commodities and capital investments.
The implications are the same for the U.S. investor. Inflation is devastating to long-term bonds. Inflation makes "safe" 10 year U.S. Treasuries not so safe anymore. As a long-term investor you should diversify into investments that are resistant to inflation. These include common stocks (domestic and foreign), TIPS, REITS, and Foreign TIPs.
Disclosure: Author has a small position in Chinese stocks. You should perform your own due diligence and consult with an investment advisor before investing.
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Fed can start buying treasuries and bring the interest rates down - that is what it is proposing to do.
In short the inflation call is not so straight forward.
We are in a deflationary stage of the business cycle right now and I think the discussion of inflation is premature as MHFT mentions above.
When you look at the Japan experience, you will notice that their inflation and sovereign debt rates have remained extremely low since they popped their asset bubble in 1989 and it is very likely that we will be no different.
Maybe Treasuries are actually cheap???
We are not like Japan. Japan was and still is a creditor nation we are a debtor nation. Two totally different scenarios.
On May 27 06:40 PM Audio Tactics wrote:
> I'm just wondering why so many people are talking about inflation.
> It's definitely the flavor of the week but I'm not sure it's a durable
> theme.
>
> We are in a deflationary stage of the business cycle right now and
> I think the discussion of inflation is premature as MHFT mentions
> above.
>
> When you look at the Japan experience, you will notice that their
> inflation and sovereign debt rates have remained extremely low since
> they popped their asset bubble in 1989 and it is very likely that
> we will be no different.
>
> Maybe Treasuries are actually cheap???
If Fed wants inflation, they can get inflation. They have the most powerful printing presses in the world: the computer.
WHEN we will have inflation and how much is debatable.
On May 27 06:34 PM Fighting Yoda wrote:
> Inflation is not so easy to create. With surplus capacity, falling
> wages, and dwindling demand - where will inflation come from? Fed
> is trying hard - printing money over time - but all we see is deflation.
> It is very hard to transmit the money for spending - job losses,
> people reluctant to borrow, banks reluctant to lend. Commodities
> etc have jumped up recently on pure speculation, and China bottom
> fishing (and diversifying out of dollars).
>
> Fed can start buying treasuries and bring the interest rates down
> - that is what it is proposing to do.
>
> In short the inflation call is not so straight forward.
The devaluation of the dollar has now started in earnest. There has been a flight out of the dollar and dollar backed assets for some time now. The world has been in the process of decoupling from the dollar. As Peter Shiff puts it, "we are not the engine, we are the caboose and we are being cut loose." When inflation first starts it will look like economic recovery has started. Moving rapidly from there to hyperinflation. It will not take long. Historically from onset to complete financial collapse will most likely happen within 24 months.
The biggest risk to TIPS is that the creditor (the US government) also calculates the official CPI. This is a conflict of interest. Along with many others, I don't trust the official US government CPI figures. The CPI statistic has indeed been fudged to make inflation appear to be lower. This cheats Social Security recipients and TIPS bond holders. No one can agree on how much the US is fudging the CPI. One economist, John Williams, author of shadowstats.com believes that the US government is fudging the CPI by 3% per year.
Suppose the author of shadowstats.com was 100% accurate. Many respected economists would join the outcry against the government cheating and there would be tide swell of a moral outrage. I believe that cheats get away with cheating for a long time as long as they keep the amounts small.
I tend to side with Bill Gross of Pimco (the bond king) who feels that the US is underreporting inflation by 1% per year. With that headwind, 10 year TIPS are slated to provide a guaranteed 0.5% annual real return.
Of course, Schiff was premature in his prediction about the dollars demise, but I am in sympathy with his general theme. Of for "total financial collapse." that's too extreme. As for 24 months, no one has a crystal ball. The US will end with a whimper not with a bang.
On May 27 07:15 PM Donald Ingram wrote:
> Inflation comes not only from surfeit of money relative of goods
> and services, but also a shortage of goods and services relative
> to the supply of money.
> The devaluation of the dollar has now started in earnest. There has
> been a flight out of the dollar and dollar backed assets for some
> time now. The world has been in the process of decoupling from the
> dollar. As Peter Shiff puts it, "we are not the engine, we are the
> caboose and we are being cut loose." When inflation first starts
> it will look like economic recovery has started. Moving rapidly from
> there to hyperinflation. It will not take long. Historically from
> onset to complete financial collapse will most likely happen within
> 24 months.
Hey, did you hear from CNBC and Bloomberg and the Wall Street Journal that the housing market is stabilizing and the PE of the S&P 500 is only 14 and that green shoots are high in fiber and can really help you stay regular?
NOTE: For those of you who actually watch CNBC or Bloomberg that last paragraph was satirical in nature.
> Thanks for writing that, Donald.
>
> Of course, Schiff was premature in his prediction about the dollars
> demise, but I am in sympathy with his general theme. Of for "total
> financial collapse." that's too extreme. As for 24 months, no one
> has a crystal ball. The US will end with a whimper not with a bang.
>
I agree. It is not in anyone's best interest for the U.S. to go under with a bang. Better that we turn into a nice, quiet European-type country that doesn't cause any trouble.
> china will do what is best for a communist dictatorship.the powers
> that be learn nothing from history because each time they think its
> different.its not.the human(brainwashed) is the same century after
> century.sad.
Generation after generation. Try www.generationaldynami.../ for some interesting reading on the subject.
On May 27 08:21 PM Fred Voetsch wrote:
> China clearly has plans to decouple from the dollar and what's amazing
> is how just like everything else having to do with finances, we simply
> ignore it and hope that everything will be ok.
>
> Hey, did you hear from CNBC and Bloomberg and the Wall Street Journal
> that the housing market is stabilizing and the PE of the S&P
> 500 is only 14 and that green shoots are high in fiber and can really
> help you stay regular?
>
> NOTE: For those of you who actually watch CNBC or Bloomberg that
> last paragraph was satirical in nature.
The only thing keeping the dollar alive is the other central banks, especially China want to keep the dollar strong so we can contiune to buy their exports. Many central banks are recently worried about the decline of the dollar and have been resorting to measures to prop up the dollar. One day they may decide it's too much trouble and give up the costly support.
During a balance sheet recession, the private sector delevers by increasing savings. This increased saving by the private sector then funds the increased borrowing needs of the public sector which must increase spending to offset the reduction in private spending.
This is why US Treasury rates are so low and will remain relatively low despite the increased borrowing needs.
The dollar is getting cheap and when I wrote my initial comment, Treasury's were cheap as well.
That is why I picked up over 15bps of profit after buying 10yr notes at a b/e yield of 3.70%
The fact that the US is a debtor nation implies that we will see a worse deflation than Japan as we do not have a buffer of household savings to fall back on during this recession. This implies even lower levels of inflation than Japan.
In addition, this recession is global and many central banks will eventually be printing money in a similar fashion.
Furthermore, China is a captive buyer of US Treasuries so don't expect this to change anytime soon.
This means that it is likely that the dollar will not fall further and that interest rates will not spike up either. Deflation should be the current concern, not inflation...
On May 27 07:06 PM Living4Dividends wrote:
> Actually, Japan had Asset Deflation (houses and stocks deflated in
> price while at the same time they had mild price inflation (food,
> oil, services rose in price)
>
> We are not like Japan. Japan was and still is a creditor nation we
> are a debtor nation. Two totally different scenarios.
>
> On May 27 06:40 PM Audio Tactics wrote:
In the long run, low yields on US investments combined with the inevitable growing inflation (I expect in excess of 10% before 2012) exert an irresistible downward pressure on the dollar.
Inevitably, China will set a new target level for the yuan relative to the dollar which has the very real possibility of a chain reaction of greater and greater pressure and the inevitable (IMHO) rise of the Euro as the de facto world currency.
The obvious ways to prepare for this is to ensure that you invest either directly in international economies, businesses that derive the bulk of their income internationally and/or businesses whose products are likely to priced in the dominant world currency.
In short, I like foreign oil companies because I believe they offer substantial growth opportunity in the short to medium term with built in hedges against current fluctuations- some of which have a very pleasant yield too.
On Jun 01 08:37 PM sabex wrote:
> The current value of the dollar is simply unsustainable. It is artificially
> supported by the fact that so many commodity prices (gold / oil)
> are dollar denominated (to buy gold, you need to buy dollars first).
> Not to mention the artificial currency support by China.
>
> In the long run, low yields on US investments combined with the inevitable
> growing inflation (I expect in excess of 10% before 2012) exert an
> irresistible downward pressure on the dollar.
> Inevitably, China will set a new target level for the yuan relative
> to the dollar which has the very real possibility of a chain reaction
> of greater and greater pressure and the inevitable (seekingalpha.com/symbo...)
> rise of the Euro as the de facto world currency.
> The obvious ways to prepare for this is to ensure that you invest
> either directly in international economies, businesses that derive
> the bulk of their income internationally and/or businesses whose
> products are likely to priced in the dominant world currency.
> In short, I like foreign oil companies because I believe they offer
> substantial growth opportunity in the short to medium term with built
> in hedges against current fluctuations- some of which have a very
> pleasant yield too.
* Living4Divi...: says ((((3. Gold, Silver and Commodities are standard inflation hedges and are very good ones. However they are expensive to store and insure and they don't pay interest. I do not advocate holding these assets in the bulk raw form, nor in derivatives, that's why I didn't mention them.))))
when you buy insurance to protect your car, do you require that the insurance company pays you interest on that insurance payment?
Gold is insurance against the devaluation of your dollars. Therefore, why would you require it to pay interest?? gold can, and often does,increase in value. So this can actually be seen as a form of interest ,so your assertion that gold does not pay interest is false.