A rather significant story to start off the week was that of China's new relationship with the U.S. Treasury, in which China will buy U.S. government bonds directly from the U.S. Treasury - not through primary dealers like Goldman Sachs (GS), UBS and other big banks that are quite unpopular these days. Here's my take on the implications of this development, and why I think it's a fairly big deal:
1. It introduces a new kind of opacity to the U.S. Treasury market. Reuters explains:
The privilege may help China obtain U.S. debt for a better price by keeping Wall Street's knowledge of its orders to a minimum.
Primary dealers are not allowed to charge customers money to bid on their behalf at Treasury auctions, so China isn't saving money by cutting out commission fees.
Instead, China is preserving the value of specific information about its bidding habits. By bidding directly, China prevents Wall Street banks from trying to exploit its huge presence in a given auction by driving up the price.
It is one of several courtesies provided to a buyer in a class by itself in terms of purchasing power.
As an individual trader disconnected from Wall Street and even more disconnected from the U.S. Treasury Department's dealings with China, I don't feel particularly comfortable participating in the Treasury bond market as a result of this development. I feel as though individuals will be at too much of a knowledge disadvantage, even more than they usually are.
2. The potential implication of China's direct Treasury buying that I have the most confidence in is that it suggests the U.S. dollar will be the last currency to fall. It's no secret that the world's major currencies have some major problems; the EU, UK, Japan and the U.S. dollar are all insolvent in that they will never be able to pay off the debt they've assumed without massive currency devaluation. However, if China is really so interested in securing U.S. debt at favorable rates, it suggests one of the biggest players in the global economy is still interested in the U.S. dollar - even in spite of its open efforts to internationalize the renminbi and thus create a viable alternative to the U.S. dollar for international trade. In my opinion, this strengthens the case that the U.S. currency will be the last or one of the last to fall - meaning that other currencies will undergo significant devaluation first.
Ultimately, though, my trading outlook is largely unchanged. I still favor shorting the U.S. dollar against commodity currencies like the Australian dollar (FXA) and the Canadian dollar (FXC). Perhaps the one difference this news story makes for me is that I'll be a bit more hesitant to enter the U.S. Treasury bond market (TLT). I rarely did this in the first place, although now I feel as though I have some more reasons not to.