The Chinese and the Fed Both Buying U.S. Treasury Bonds

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“China stuck in dollar trap,” says the headline on the front page of the Financial Times.

The FT says China is buying more U.S. bonds than ever. It must…according to the news report…because it has too many. Unless it supports the dollar, it risks a big collapse in the value of its foreign exchange holdings (mostly in dollars).

China has its finger in the dike. But it may need a bigger finger. This morning it is trading at $1.40 per euro – a new low for the year. Measured against gold, it now takes 958 dollars to buy a single ounce of gold.

“We have a huge amount of money in the United States,” said Wen Jiabao, premier of the People’s Republic of China, back in March. “I request the U.S. to maintain its good credit, to honor its promise and to guarantee the safety of China’s assets.”

In response to this request, U.S. Secretary of the Treasury, Timothy Geithner, answered in the positive. Whether he had his fingers crossed behind his back, or not, we do not know. But for the moment, the United States is honoring its promises in the short run…but doing so in such a way that dooms the Chinese in the long run.

Now, the Fed is buying U.S. Treasury bonds. So are the Chinese. Supporting each other, they are also supporting prices of bonds – which happen to be the largest single source of financing for the U.S. government and the largest single liquid asset of the Chinese government. Despite the support of the biggest investors in the world, the price of bonds and the price of the dollar both sank last week. Which makes us wonder: what happens when both the United States and China turn into sellers?

That may not happen soon. But it will happen.

For now, the United States has to sell trillions more in bonds to finance its imperial ambitions, bailouts and boondoggles. The Fed will have to buy them…along with the Chinese. If stocks fall – as we expect – they are likely to be joined by many other buyers too – all seeking safe haven in the world’s leading credit.

But at some point, as always, what must happen will happen. Not forever can the United States spend $2 for every dollar it receives in tax revenues. Not forever can the Chinese support the value of a bad investment, in which they are already too heavily invested, by buying more of it. Not forever can the dollar hold its value when the Fed is busy creating hundreds of billions more of them. And not forever can the Fed continue to inflate the currency when the dollar is falling.

Since the Fed inflates by buying bonds, when consumer price inflation begins to menace the bond market, it must deflate by selling them. When that moment approaches, even if it is months or years ahead, Daily Reckoning readers are warned: that will be a bad time to be visiting China…and a bad time to be holding U.S. Treasury bonds…and a bad time to be standing behind the dike.

Meanwhile, the International Herald Tribune says that Latvia is being crushed under a huge government deficit. Formerly middle-class citizens are out of food, says the paper. Further down on the socio-economic ladder are scenes of “Dickensian misery.”

What provoked this horror, according the IHT, is a current budget deficit equal to 12% of GDP.

Wait! The US budget deficit is 13% of GDP. Sooner or later, that deficit will crush Americans too…

Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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Comments

  1. The bad economic data keeps coming out of the US – House prices are down another 19%, Obama says they’re broke, GM is screwed and the Big Banks are in it deep; yet the Dow keeps going up….What the hell is going on? I give up, this is just screwing with my head! Maybe Bill or the Mogambo can make this make sense….

    Reply
  2. I’m with you Tim. It’s screwing with my head too. I just wish the dam would break and we could see what each pice looks like without them being obscured in muddy waters.

    Reply
  3. “How can the country’s stocks rally while the economy keeps contracting…

    “It’s only a mystery if you look at the situation conventionally. Practitioners of Elliott wave analysis, on the other hand, know that economic news neither creates nor drives trends in the stock market. The economy follows stocks — a fact overlooked by the absolute majority of investors and their advisors. It’s as true in the emerging markets as it is in the Western ones: Notice that the DJIA topped in October 2007, before the U.S. economy tanked, and bottomed in March 2009, before the economy showed signs of life.

    “This is powerful knowledge. If you start looking at the stock market as a leading indicator, then while others are pouring money into the next bubble, you will know it’s time for caution. And when they panic and hoard cash (as they did at the March lows), you will know to look for a buying opportunity. Isn’t that what “buy low, sell high” says you should do?” (Vadim Pokhlebkin, Russian Stocks: What’s Driving the “Mystery” Rally? elliottwave.com, May 26, 2009).

    NB. I monitor the elliotwave crowd not for their wave-charts but for their socionomic insights.

    As noted before the 1970s provide the best ‘rhyme’ with the past to view the future so that the present rally it rhymed with 1974-76 which started three months before the end of the recession.

    Reply
  4. You do not get it! Obama wants the nation to fail given that he attended a Muslim school as a youth and believes the only way to help Islam defeat the Great Satan is to destroy it from within with the help of his extreme leftest buddies who wish the same fate for the United States – economic collapse in order to usher in a Communist Utopia! Even the Supreme Court Justices are in on the act by tying up attorney Berg so his charges Obama is illegal cannot see the light of day – most of the justices are true communists and want to see a new order that exculdes capitalism. Obama knows his buddies are nuts, but the death blow to the U.S. economy will still achieve his objectives.

    REMEMBER HE BOWED TO THE DEFENDER OF THE MUSLIM FAITH because he is a true Muslim.

    Arnold Roquerre
    May 31, 2009
    Reply
  5. Arnold, if this is satire, it’s really very good.

    Reply
  6. Arnold – you are completely off your Roquerre.

    Reply

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