It seems that the more US Treasuries soar (NYSEARCA:TLT), so does the discussion about the bubble bursting. Is this bidding, which has brought US Treasury prices to historical highs, the result of some desperate, fear-driven run, or is it a well-planned strategy addressing a legitimate diversification need major world earners have? Tracking the buying patterns of US Treasuries, one can easily detect that it is creditor nations leading the show. It would seem that debtor nations are trying to finance their deficits by having creditor nations pay the bill. Perhaps that would explain why Western policy makers insist on keeping the discussion about helicopter-money scenarios alive, when their Eastern counterparts have adamantly denied them. As crazy as such a scenario is since it would ultimately add more debt to whatever economy decided to implement it, and impair that country's currency, from a tactical standpoint it makes perfect sense. The US, being the biggest debtor nation, must absorb the buying power creditor nations have, by having them invest in US assets. Under such light, the answer to the US Treasuries rally could be summed up in one simple sentence, "It's the surpluses, stupid!"
Who is Buying the US Debt?
Contrary to popular belief, US Treasuries are not a scarce and concentrated asset. The first quarter of 2016 revealed that only 42% of the total US debt remained in FED's hands and government accounts. This means that the majority of US Treasuries have been dispersed amongst domestic, and more importantly, international holders, who control almost 1/3 of the total US debt. When compared to Q2 of 2007, just before the recession broke out, the US government owned more than 53% of its own debt. Today, not only does it own 9% less, but it is foreign investors who have amassed the largest chunk of it, have increased their positions to almost 33%.
Currently, the most avid foreign buyers of US Treasuries are creditor nations that don't have much choice but to invest the proceeds of their trade surpluses in global reserve currency assets. These buyers have a hold-to-maturity mentality, due to their sovereign investor profile, and are willing to absorb new supply, provided that they keep on having surpluses and the USD retains its global reserve currency status. Since the US is fully reliant on these surpluses to keep its economy afloat, it must make sure that these prerequisites are met. For this reason rate normalization is necessary in order for the Fed to instill faith in the US currency, and to keep the willingness of the world's lenders to buy USD denominated debt, alive. While such a move is not expected to happen in the short-run, US policy makers, nevertheless, have begun paving the way for an interest rate hike.
The New "Mask" of Fiscal Policy
Since the US is on the prowl for surpluses, much pressure is applied to creditor nations to increase their fiscal spending. One need not look beyond Japan to see how the US is trying to strong-arm the second biggest holder of US Treasuries to proceed with a helicopter money action, which if implemented would not only boost the Japanese economy, but it would also have a multiplying effect on the surpluses of Japan's trading partners. This would increase the amounts of potential buyers of US Treasuries, thus guaranteeing the US a consistent way of selling off its debt to foreigners. Therefore, it is not at all coincidental that as soon as Japan's US Treasury holdings dropped last year, the heli-money discussion emerged, and won't die down.
The reasoning behind this rests on very specific mechanism: the more you fiscally stimulate an economy, the higher the demand for imported goods will be. In other words, the more a country spends, the greater the gain for its trading partners, who take advantage of the high income elasticity of demand for their exported goods. Japan's biggest Asian trading partner is China, which also happens to be the biggest holder of US Treasuries. If Japan succumbs to US pressures and increases its fiscal spending, then China is first in line to benefit from this boost. Along with China, South Korea, Taiwan, Singapore, Saudi Arabia, and the United Arab Emirates will also see an increase in their surpluses as they too are major trading partners of Japan, and surprise, surprise major US Treasury holders. So, in essence, the US is extremely tactical, even surgical, when it comes down to what nations it will apply pressure on for increased fiscal spending. It will choose those that will have the maximum impact on its debt sustainability, by playing one song that many can dance to. Fiscally stimulating Japan doesn't only guarantee Japanese surpluses translating into US Treasuries, but it also carries over to the strengthening of its A-list buyers. This creates a huge pool of prospect buyers the US can rely on, so it can continue to feed the appetite for US government bonds.
This orchestrated pressure may also accommodate Fed efforts to unload its treasury holdings portfolio along the way. At least this is what American monetary masterminds aspire to achieve at this critical juncture of historically high bond valuations. The recent reference made from South Korea's CB governor about the need for stepping up fiscal policy action can also be seen as an example of US propaganda. The same holds true with the most recent G20 statement that was emphatic about the importance of fiscal policy coordination and structural reforms. It wouldn't come as a shock if down the line US propaganda starts aiming at China, suggesting for a heli-yuan scenario.
The US government bond highs might in fact be a bubble, but this bubble won't burst anytime soon, as long as surplus nations keep expanding its elasticity. The US bets on these surpluses as the only reliable short and medium-term support mechanism, and for that reason will do all it must to keep this cycle going. Deciding to bet against US Treasuries, is exactly the same as betting against the power and influence the US has over the world. History has proven that the most nuclear weapon the US has at its disposal is its propaganda machine, and it has already started launching its first missiles, and hitting its marks. Which surplus nation is strong enough to withstand US rhetoric?
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Additional disclosure: The views expressed in this article are solely those of the author, provided solely for informative purposes and in no case constitute investment advice.