If Ireland Dumps Its Treasuries

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Includes: IEF, TBT, TLT
by: Alan Longbon
Summary

Ireland has a surprisingly high holding stock of US treasuries.

What would happen if for some reason Ireland were to dump all its treasuries.

The Fed is mandated to maintain the FFR at the target rate and would immediately sell new treasuries to the primary bank holding the excess reserves.

Ireland has, after China, Japan, and Brazil, the largest holding of US treasuries. This is shown in the chart below.

Many market commentators and conspiracy theorists are postulating that angry international trading partners might dump their rather significant holdings of US treasuries as revenge for US trade tariffs, boycotts, bans, and sanctions.

2018 Holders of US Treasuries

Ireland has over $280B of US treasuries. These treasuries came into being as a result of Ireland's export income from international trade with America.

Ireland exports by country (Source: Tradingeconomics.com)

The table below shows the items that Ireland exports to earn its treasury holdings with the USA.

Ireland exports by category (Source: Tradingeconomics.com)

Ireland has set itself up as the preferred corporate headquarters for international companies. Ireland offers lower company tax rates in addition to first-rate developed world infrastructure and an educated workforce. For this reason, Ireland, at least of paper, appears to have a lot of treasuries. However, these are owned by companies like Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and other large American companies headquartered in Ireland.

External trade has a significant influence on the Irish economy. The impact of trade is shown in the chart below.

Ireland balance of trade as a % of GDP Foreign trade is over 9% of GDP each year, in surplus and growing. The USA, for example, is not so dependent on trade, and the external balance represents only about 2% of GDP as this report shows.

The Irish have sent real goods and services to America for decades and are happy to save the income as dollars at the Fed and place them in treasury accounts to earn interest.

The thousands of businesses that export to America all have an account with a US bank that in turn has an account at the Federal Reserve Bank (Fed). In these American bank accounts, the dollars accumulate as goods and services from Ireland are bought and paid for by domestic Americans. The dollars move from a local American's bank account to a US bank account in the name of an Irish entity. The Fed groups the bank accounts under a sub-account for Ireland.

In theory, the Irish entity could spend those US dollars and buy anything offered for sale in US dollars. The dollars could re-enter the US domestic economy in return for US goods and services or assets, or move to another foreign dollar holder in exchange for something else.

The point to remember is that the dollars never leave the Fed's spreadsheet. All that happens is that they change ownership in exchange for goods and services. The Fed marks accounts up and down to track the dollar movement like a referee keeping the score at a football game. Just like a referee, the Fed creates dollars out of thin air as required in the same way a referee awards points.

US law prevents the Irish and other foreigners from buying anything significant for sale in US dollars (more than 5% of shares in a company and strict absolute dollar limits, some industry sectors are totally out of bounds). They have little choice but to put 95% their excess dollar holdings into a savings account and earn some interest. Foreigners are encouraged to buy US treasuries (that accrue a coupon payment like a term deposit savings account) with their surplus dollars. The alternative is to keep the dollars in their checking account, earning no interest. A checking account at the Fed is known as a Reserve account. (Checking = Reserve and Saving = treasury in Fed terminology, Reserves = Money, the Federal Reserve System could alternatively be named the "Federal Money System" and lose some of its mystique).

Since 1960 the United States has drawn on world resources through a novel monetary process: by running balance-of-payments deficits that it refuses to settle in gold, it has obliged foreign governments to invest their surplus dollar holdings in treasury bills, that is, to relend their dollar inflows to the U.S. treasury. - (Hudson, Michael. Global Fracture: The New International Economic Order (p. 17). Pluto Press. Kindle Edition.)

At the moment, the Irish export earnings are in a savings account known as a treasury (earning interest) instead of dollars in a checking account making nothing. If they move their dollars from savings to checking, they get no interest earnings on their dollars.

Here, it gets tricky and departs from your knowledge of banking and enters the world of international reserve banking that practically nobody outside of the industry understands.

If the Irish moved their treasuries (savings) to reserves (checking), the US primary dealer bank that holds their US bank account for them would then have excess reserves.

Then, the interest income would go to the primary dealer bank where the Irish have their bank account. The interest income would go into the private domestic sector via the interest on excess reserves, or, interest on treasury deposits bank income channel. The interest income becomes income for the private domestic sector (the banks) instead of the foreign account holder.

No sensible country with knowledge of reserve banking would choose to hold their dollar export earnings in cash rather than interest-earning treasuries. Nor would a country want to trade with America if it were not content to save those earnings as dollars or treasuries.

There would be no sudden interest rate change. The Fed's mandate is to maintain its Federal Funds target Rate (FFR) by buying and selling treasury bonds. If the Irish sold their treasuries, the excess liquidity would be immediately mopped up with a bond sale to whichever bank held the excess cash. If the Fed did not do this, the excess bank reserves sitting in the banking system would push the interest down below target.

Since the GFC, there have been trillions of dollars of excess reserves left in the payment system. The Fed has been paying interest on those reserves and interest on excess reserves which sets a floor under the interest rate. The primary bank holding the excess reserves, from the sale of Irish owned treasuries, would earn interest on excess reserves. Another alternative is to buy higher-yielding Treasury bonds.

There would be no exchange rate implications as the number of dollars and treasuries on issue remain the same. All that happens is a portfolio swap - paper assets for cash, a wash.

The most likely thing to happen from the Irish, or any other primary holder of US treasuries, exiting their treasury holdings would be a brief market panic brought about by news headlines informing the public of the event and drawing the wrong conclusions from it and adding to the fear and misinformation.

So, it is not going to happen, and if it does, it does not matter.

The worst thing that can happen is that the rest of the world decides not to send real goods and services to the US in exchange for dollar credits on the Fed's computer. Then, we will have to make them ourselves, and this would import jobs, pollution, and inflation. The reason we import those things in the first place is that they are cheaper to make and produce overseas (generally because of the lower environmental and labor protection standards). By not importing means buying the more expensive domestic offering using resources that might have been better employed on some other more efficient tasks.

So, one can buy US Treasuries in the knowledge that they remain a risk-free income-producing asset (TLT) (TBT) (IEF) in the largest and most liquid bond market in the world.

The fact that the bond markets are rallying at present due to the treasury drought is even more reason for confidence. The treasury drought and its implications are discussed in this article.

The President has signed into law both the debt limit deal and a Federal budget deal that ends the treasury drought and will bring a return to higher bond yields soon.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.