Phorgy Phynance

Telegraph: China threatens ‘nuclear option’ of dollar sales

with 9 comments

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:

China threatens ‘nuclear option’ of dollar sales

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.

aaron replied:

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:

Paulson: US should boost debt limit


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.

I responded:

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!


Written by Eric

August 8, 2007 at 12:15 pm

9 Responses

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  1. Dude, not grumpy, just trying to engage you in some thinking as a result of your speaking. It’s well and good to have your dire predictions in possibly the worst market in 7-10 years, but you are really not backing up your assertions with facts. I mean if China has really been disinterested in buying I’ll take the quarter point rally in rates from mid July as a side effect. As much as people like to buzz on and on about this, it is in fact more thunder and less lightning. Assuming that China’s currency reserves stated to be 400Bn US has 4.9 Trillion outstanding, that would mean china has approximately 8% of the outstanding US debt there. No matter how much you may want to nuke someone, you don’t unload 8% of the holdings in an uncontrolled manner. Assuming that it’s all in 10year T’s duration 7.5 and they succeed in moving rates 1/2 point and the movement happens equally through the liquidation they’ve managed to inflict a tit ripping 7.5bn loss on their position. Not saying they won’t do it, but 7.5bn seems like a lot to hand grenade us for a few weeks/months.

    The idea that someone releasing 8% of likely the most liquid paper in the world back into the pond will cause a long term economic crisis is ludicous at best. The market may move a little bit, but whatever, it’s not going to stay that way, and the guy selling into it gets hurt. The kicker will be that China dumping will not be viewed as an indication of unsoundness in US treasury paper but a political move.

    You can bang the drum of doom all you want but until you can provide some alternatives or ways to capitalize on all of this I’m going to continue to view you very skeptically. Turtle up if you want, but this is where it gets fun.


    August 8, 2007 at 4:17 pm

  2. Hi RRP!

    I would never take a break from NP to avoid discussing this stuff with you and I’m really glad you’re here commenting. If you were grumpy at all (which I’m not sure you were), at least you were reasonable. I enjoyed our discussions and was learning a lot and appreciated the time you took to respond. I’m STILL learning. I think others did not appreciate much what I had to say though as I was warned via email a couple times due to several complaints. I’m taking a break in the hopes of retaining any good will that still remains there as I value the NP community a lot more than you know.

    Anyway, back to the subject…

    China HAS been reducing their holdings in US treasuries. At first, reports came out that they were net sellers, but it turned out that they had just stopped rolling into new bonds as existing bonds matured.

    Countries ARE diversifying away from USD.

    Oil IS disentangling from the USD as oil exporting countries are beginning to sell in yen, rubles, eur, etc.

    Credit IS overpriced still in my opinion. I just read something today that said there hasn’t been a HY new issue since July 26. Maybe by holding out, things will moderate when they finally do come out, but there is already a MASSIVE pipeline in HY and the delayed issues are just going to make matters worse. Who is really going to want to buy all that crap, especially at historically low yields. I wouldn’t be surprised to see HY spreads go out to 8-10 pts (not bps).

    I may not be expressing myself very well, but I AM really thinking hard about all this stuff. Day and night. You can almost say I am obsessed with the markets these days. I absolutely love this stuff and look forward to being able to put my money (which I have very little of now) where my mouth is. In fact, just this morning I put on my first (ever) trade on of $2k. Woohoo! Gotta start somewhere 🙂

    By the way, just to clarify something, I’m not expecting China to dump all their USD holdings either. That is a bogus threat, but I do think they may diversify further away from USD and I think they aren’t the only ones doing so. Russia isn’t particularly happy with the US now either. Middle East? That would put even more pressure on the USD and would attract investors to EUR (and the Yuan if the US gets its wish of a floating Yuan) even more than they are now.

    I’ve seen portfolio managers manage more money individually than most HFs have in total (and more than some country’s GDPs) and they base their investment decisions on the type of “thinking” that I am trying to perform here. They have analysts to do the number crunching for them and in my case, the blogosphere has become my army of analysts. The key, in my opinion, is to be able to form investable opinions by filtering massive amounts of information.

    Your comments are challenging me to try to find ways of expressing myself better and I really appreciate it. I think I am improving (slowly and painfully).


    August 8, 2007 at 5:11 pm

  3. Eric, dood,

    just as a sidenote, there is a difference between theory and practice. And yes, there is a difference between analyzing the markets in theory and seeing (and feeling) what goes on in practice. It is naturally that markets puke once in a while although this is the worst move I have seen so far but half of what you see is reality and the rest is imagination (or call it psychology). For example, nobody wants to buy IKB CPs right now, although they are KfW (=state) guaranteed. This is just ridiculous and market is currently overdoing it.

    Wait and we will see.


    August 9, 2007 at 7:27 am

  4. Have you seen the jump in overnight money market rates and the intervention of the Central Banks ? This is for real and it means someone out there is in deep sheah. Forget about China, we see a significant lack of liquidity here right now.


    August 9, 2007 at 8:01 am

  5. Master Cheng dude! 🙂

    I hear you on the “theory versus practice” thing, but I’m a little confused about which side you’re putting things. We’ve got two pairs of terms “theory versus practice” and “fundamental versus psychological”. We can even form one of those game theory squares 🙂

    [By “real”, I think you meant “fundamental” because if my company goes bankrupt because of psychology, then the psychology seems pretty “real” to me. I know it is just semantics, but I think I’ll use “fundamental” instead of “real”.]

    1.) theory – fundamental
    2.) theory – psychological
    3.) practice – fundamental
    4.) practice – psychological

    Theory does try to get at fundamentals, but increasingly theory is trying to get at psychological factors too via behavioral finance, etc.

    To the extent that each theory fails is measured versus practice. In practice, there are fundamental factors not contained in any theory and there are psychological factors not covered by any theory.

    My goal is to eventually have some kind of handle on all four squares.

    Now, you say the fact that people will not buy IKB CP is ridiculous, but what could be some reasons for that? [That is not a rhetorical questions. I’d like to know.] I don’t think people are necessarily holding a big bag of cash (or CP 🙂 ) with a long shopping list and consciously decided to cross off IKB CP. I think people just don’t know WHAT to buy right now, if they can even buy anything at all. Maybe until things settle down, investors would just assume sit on cash (not even CP) for a while until they have some clue what’s going on.

    I think I have a real advantage for thinking through this stuff relative to you and other kung fu experts. You are all TOO SMART. I’ve been blessed with stupidity and have made every mistake one could possibly make, so I understand how others could make mistakes. This also explains why I am a good teacher, i.e. I can empathize with my student’s difficulties. It’s the really smart people who have difficulty understanding this stuff 😉

    After all, it is not the smart people who run the world, right?


    August 9, 2007 at 8:03 am

  6. Ouch, just saw your previous comment 2 minutes before my last. Yeah, I heard about the ECB infusion. Serious stuff.

    Again, I think the IKB CP thing is not so ridiculous, i.e. they are not looking at it and deciding not to buy sovereign backed paper, they are just paralyzed in general right now.


    August 9, 2007 at 8:06 am

  7. Put it this way. The cost of living will skyrocket. Food/energy will be unaffordable. People will not have any buying power except for those printing the money. I hope you stock up on food now or learn how to grow seeds. All of USA will have Foreclosure signs.


    December 31, 2007 at 9:39 pm

  8. On that note, Happy New Year! What a wild ride 2007 was. I suspect it will pale in comparison to 2008 though. Fasten your seatbelt!


    December 31, 2007 at 10:09 pm

  9. […] quoted part of the discussion here when I first learned of the amount of US debt held outside the […]

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