Our main export over the last 20-plus years has been the U.S. dollar. We've run up huge trade deficits, sending dollars over seas to China, Japan, Korea, the EU, the Middle East, and to anyone else who would take them in exchange for their goods. The virtuous cycle has worked until now because the giant vendor financing scheme suited every one's interest. U.S. consumers got cheap goods from overseas and were allowed to spend beyond their means by borrowing cheaply. Export led foreign economies were able to sell into one of the largest consumer economies in the world, keeping their labor forces employed and running up huge surpluses in the process (reserves are a wonderful thing when hard times hit, since you have to pay back international debt regardless of whether you're earning sufficient currency or not).
But what to do with the tsunami of dollars flooding their shores? How to avoid the Renminbi, Yen, Won, Baht, Peso, and Real, among others, from strengthening and thus decreasing the competitiveness of their goods in the world market? Why, recycle all of those excess dollars back into the U.S. by purchasing the (until now) safest investment in the world - U.S. Treasuries. Buying U.S. Treasuries with surplus dollars had the beneficial side effect of keeping U.S. interest rates far lower than they would otherwise have been, in turn stimulating the U.S. consumer to take on even more cheap debt with which to buy more foreign goods.
Clearly though the trend was unsustainable and had to come to an end eventually. At some point the foreign vendors financing our purchases would want to get something tangible in exchange for their store of paper money. Now it increasingly appears that the end is near as America's policy of dollar debasement is obviously vexing the foreign holders of U.S. debt.
China, in particular, appears to be signaling that it is serious about ending the trend. The Chinese have accumulated some $2.2 trillion in U.S. debt, primarily U.S. Treasuries. but lately they have been signaling an end to unlimited Treasury accumulation. Instead they have been diversifying away from US Treasuries by using the roughly $200 billion accumulated each quarter to buy other currencies and assets. More ominously for the U.S. Treasury market, the Chinese are now indicating a desire to actively sell Treasuries in order to buy U.S. strategic assets, according to Chinese official Li Daokui in a statement made at the World Economic Forum.
"We would like to buy stakes in Boeing, Intel, and Apple, and maybe we should invest in these types of companies in a proactive way," Li said at the Forum. "Once the US Treasury market stabilizes we can liquidate more of our holdings of Treasuries," he went on to say. HELLO?
The Chinese liquidating their Treasury holdings isn't a dollar negative if they use the proceeds to buy American assets, but it could send the bond market reeling, driving up interest rates and throwing the United States into recession in the process. The Federal Reserve is already financing the entire budget deficit (and has been for almost two years now). Is the Fed ready to prostitute its balance sheet further by stepping into the breach to buy China's Treasuries if they follow through with their plans to swap out T-bonds for hard assets? Perhaps. But will the rest of the world allow the Fed to get away with it for long? Not likely....
Dollar dumping by the major holders of our debt is a growing possibility, with serious consequences likely, not the least of which are rising interest rates and an economy in recession. Neither bonds nor stocks will weather that particular storm very well.....
