Telegraph: China threatens ‘nuclear option’ of dollar sales
Holy crap. I first heard about this a couple hours ago while listening to BBG TV’s online stream. A quick google later turned up a bunch of hits, including this one from the Telegraph:
This reminds me of a dialogue way back when (about a week ago) on NP.
On July 25, I made a bit of an apocalyptic statement:
I also suspect that a “sovereign” flight to quality will not be a flight to US treasuries and in fact may be a flight away from US treasuries into EUR denominated government bonds. So as the credit market turns, the typical safe haven will not be available as even treasuries get whacked from sovereign sellers.
I didn’t change my icon for no reason. Loose monetary policy (the failure of Greenspan and Bernanke) created unsustainable excesses. Credit markets are about to get totally whacked. Equity markets will last a little longer than credit due to M&A activity, but even that will not last long and then equities will feel the pain.
Wild times as seen through the eyes of an admittedly clueless armchair analyst
Then I followed up on a brief comment from RRP:
[From RRP:]You’re not experiencing defaults triggered by a broad downturn in the economy.
Not yet. That is why I’m keeping an eye on the USD, oil exporters, and sovereign debt holders. Increasing weakness in the USD will force the Fed to raise rates, which I think they’ll have to do anyway. China is no longer a place we can continue to export inflation. Those who think the Fed’s next move will be down seem to be out of touch with reality.
Then, on July 26 I continued:
Regarding treasuries, close to 50% of all outstanding US government debt is held outside the US.
US financial watchdog says economy at risk from ‘non-ally’ bondholders
David Walker, the US comptroller general, indicated that the huge holdings of American government debt by countries such as China, Saudi Arabia and Libya could leave a powerful financial weapon in the hands of countries that may be hostile to US corporate and diplomatic interests.
Mr Walker told The Times that foreign investors have more control over the US economy than Americans, leaving the country in a state that was “financially imprudent”.
He said: “More and more of our debt is held by foreign countries – some of which are our allies and some are not.”
Mr Walker, who heads the Government agency that is responsible for auditing the national accounts and is also the arm of Congress that scrutinis-es spending by the Administration, said that the US has been forced to rely on foreign investors more because Americans are saving so little.
I don’t think anyone’s fleeing to Europe in a credit crunch, maybe China. Yes, ever since 1971, the dollar has become a fiat currency, worth whatever the US government says it’s worth. The Euro is a fiat currency with no government behind it. On top of that, EUR-denominated leveraged loans are in worse shape than dollar-denominated. They were worse in the first place, and have been hurt (while USD borrowers have been helped) by the strengthening of EUR against USD.
I’ve never understood the argument that foreign ownership of treasuries is a threat to the US. If everyone who didn’t like me lent me money, I’d be happy. I’d be even happier if I got to pay them back with paper I wrote myself. In the 60’s and 70’s, the US sold a lot of debt to foreigners and inflated its way out of repayment. In the 00’s, the US sold a lot of debt to foreigners and devalued its way out of repayment. But people keep lining up to buy more. I don’t see that changing.
To which I replied:
Regarding soveriegn debt, sure a fire sale of US assets would hurt themselves as well, but you can already see the beginning of the migration, e.g. reserves diversifying away from the USD, increasing amount of oil being purchased in currencies beside USD.
I’m not sure I’m so enthusiastic about the idea of inflating your way out of foreign debt obligations. That wouldn’t be so great for the domestic economy. Something like what Russia did, i.e. a flat out default, as crazy as it sounds, is seeming like more of a possibility to me though.
Then, on July 31, I posted the following:
Treasury Secretary Henry Paulson on Monday said the United States may be unable to pay its bills this fall unless Congress raises the government’s borrowing authority, now capped at $8.965 trillion.
Economists doubt Congress will refuse to raise the limit. A federal default is considered unimaginable because it would rattle bond markets, force interest rates higher and shake the economy.
Baby boomers haven’t even begun retiring en masse yet…
To which I got slammed again (grumpy people these days *sheesh*), but RRP made the following reasonable comment:
Raising the borrowing limit happens all the time. We are running at a budget deficit, so what? We’re fighting 3 wars which gets expensive and giving tax cuts away like candy and running at an operating loss, shocker. Long term it’s not doable, but we’re talking really long term, like you collecting social security long term.
Since when is having a long term view a bad thing? And since when is the Fall long term? With yields widening and the US (by that time it will be obvious) starting to hurt financially, and in light of sovereigns diversifying away from USD, how much demand is there going to be? I think in the Fall, we’ll see a widening in Treasuries even though corporates will not be in great shape. This is all related to overly lax credit standards and the impact sovereigns can have on the US market.
About this time, I swore off NP for a while as they were just getting too grumpy 🙂
So putting the pieces together, what does that mean?
It means the US is screwed. It also means that China, in particular, will be even less interested in buying US treasuries than they have been lately. We’ll see what happens if Paulson gets his way and congress increases the debt limit. The subsequent auction (in September?) should be interesting. US treasuries could get a lot cheaper. That would also exacerbate the housing troubles because as the treasury rates increase, mortgage rates can only go up as well. The one two punch!