Tuesday, February 16, 2010

China is Selling its U.S. Bond Holdings

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

China was a net seller of U.S. treasuries in December. It was also a net seller in November. Figures from the U.S. Treasury department indicate that China lost its position as top holder of U.S. government debt to Japan at the end of 2009. Despite China's selling, foreigners overall were nevertheless net purchasers of U.S. treasuries and notes in December. They were however net sellers of U.S. corporate debt for the seventh straight month in a row.

Chinese lending to the U.S. government was a key source of funding to support the U.S. spending spree in the first decade of the 2000s.  This is what allowed the U.S. to run budget deficits of around $400 billion in 2003, 2004 and 2008. These deficits were a record at the time and were considered outrageous. The U.S. is now facing a deficit of around $1.6 billion in fiscal 2010 - four times larger. Even if the Chinese substantially increased their lending to the U.S., it isn't likely they could do so by enough to fund this amount of U.S. borrowing. If the last two months of 2009 are any indication, it looks like China is not going to increase its purchases of U.S. treasuries at all, but will be selling them instead.

There is no other major external source for funding for the U.S. deficit. Every large economy has its own economic and bailout problems that it needs to worry about. The EU, which has flat GDP growth, will be putting together a bailout of Greece this week. Italy, Portugal, Ireland and Spain are waiting in line and will be looking for handouts in the future. Great Britain also has a weak economy and has been funding its operations with money printing. Japan has still not recovered from its 20-year economic malaise.  The U.S. has to compete with the needs of these countries for international capital.

There are two likely outcomes that will allow the U.S. to fund its deficit. Higher interest rates on U.S. government debt will bring more money into the U.S. bonds. Rates would have to be a lot higher than current levels though to bring in enough money though. The other option is more money printing or quantitative easing - the U.S. government purchasing its own bonds. Some combination of the two will take place. U.S. treasuries already lost 3.9% in 2009; bigger losses should be expected in 2010. Inflation protected TIPS were up 10% on the year however (not nearly as much as inflation sensitive gold's 25% rise). It looks like U.S. bond investors were already anticipating this year's funding problems last year.

Disclosure: None.

NEXT: The U.S. Imports Inflation

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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