Why Americans will suffer moreOctober 24, 2008
The problem facing everyone is a loss of American demand. Americans don’t earn enough income, they have no savings and foreigners are refusing to lend them any more money. Americans are losing equity in their homes, their stocks and their pension funds. When Americans stop spending on domestic or foreign trinkets and automobiles, companies have the option to export those items somewhere else. When Americans stop spending on services, the companies close their doors. The majority of Americans work in the service sector. This is not the 1970’s, this is not the lost decade in Japan. When Americans stop spending and the service sector shuts down, unemployment will rise dramatically as the downward spiral is re-enforced. The problem facing foreigners is exactly the same, a loss of demand, but they are only experiencing a loss of demand because they depend so heavily on American consumers. Do they really need American consumers to purchase their products, couldn’t demand come from anywhere? How about from themselves? It’s much easier to stimulate demand in a poor country than a rich country. If you have two people, one who has a $300k mortgage on a $200k house, $80k invested in his 401k, just lost a small fortune on the stock market and is nervous about losing his service sector job, and one who has saved $500 after years of hard labor and is more concerned about a stable supply of food than credit markets – and you give them each $1000 dollars – who is more likely to spend it? Who is more likely to create demand in the economy? That $1000 is a fortune for the second guy, his wealth effect will be much greater than the first. The first guy will probably hoard it or pay some bills. So what’s my point… everybody has a problem, but the solution is easier and cheaper in poorer “supplier” nations than in America. It will take many more dollars to replace lost demand in America than it would in Asia. That’s my point. The best way Asia can resolve their crisis is to let the dollar collapse so American purchasing power can transfer to where it would be more effectively spent, in their own countries, raising the standard of living. The only question is whether they have the money to accomplish this feat… I believe the answer is yes, but only if they act quickly before America debases the dollar in order to repay its debts. There is a time limit, there could come a time when their loses on American loans will simply be too large and they will also be forced to inflate to stimulate demand. On the other hand, for America to resolve its problem, it needs to restore a base of savings… That means a massive protracted economic decline until their rate of consumption more equitably reflects their share of global production, that sounds more painful to me.
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I completely agree. At some point in the near future foreigners will realize that they will be better off unloading their holdings of Treasuries at fire sale prices instead of holding onto them and seeing the value of their investments evaporate before their eyes. However, it’s possible they have already started to liquidate their holdings - we have no way of knowing.
The bond market in the United States is completely over the counter (OTC). In other words, bonds are not traded on any organized exchange. The reason why is that the bond traders do not want improved price discovery, which would hurt their margins. Here is why this is so crucial. NO ONE knows who currently holds the Treasury securites that exist in the market!
BUY AND IMMEDIATE SELL TECHNIQUE
Yes, China and Great Britain have been increasing their PURCHASES of new issuances of Treasuries during 2008 (purchases can be tracked). However, we have no way of knowing if they are also simultaneously selling these securities in the open market immediately after purchasing them. China could be liquidating a majority of its holdings, and we would have no way of knowing aside from seeing interest rates on Treasuries spike. If China has been liquidating its holdings the Teasury could have been compensating for this by creating artificial demand for Treasuries (i.e., by trading Treasuries for toxic MBS securities as part of its bailout package with Wall Street). It’s in China’s best interest that the Treasury auctions don’t fail, so the “buy and immediate sale” technique could be a viable approach for them.
I personally put a lot of weight in Lindsey William’s call for the dollar to be devalued in 2009. The government can try to delay the inevitable, but it is becoming increasingly clear that the U.S. has absolutely no chance of staying current on its interest payments, paying for social security, medicaid, medicare, etc. without significantly devaluing the dollar. It’s tax receipts in upcoming years are going to be pathetic, and it’s debt load has been constantly increasing. The only reason it has been able to make its interest payments is because interest rates on Treasuries are at historic lows. If yields on Treasuries reverted to historical norms the U.S. would likely default on its debt. It’s laughable that market participants are flocking to the “safety” of Treasuries now.
I hate to be laughed at, due to my fragile ego and all, but I am one of those people who have flocked to the safety of treasuries.
I am no economic expert, as you will see, but I don’t understand why that’s a bad move given what you describe. I don’t see how someone who invests in treasuries will have any more ill effect than anyone else from the devaluation of the dollar, except those who are wise enough or lucky enough to find really good investments before everyone else does.
The argument goes like this — the only thing worse then a dollar today, is the promise a dollar 30 years from now. Nobody who is buying treasuries today can reasonably believe that a few percent yield will compensate them for the loss of purchasing power that could be just around the corner. Perhaps they are speculators, like the people buying high-tech stocks in the 90s of real estate a few years ago. The Fed has announced they will step in to buy Treasuries from the government — they would not be doing this if there was enough demand for US dollar assets to justify current price levels. That doesn’t mean Treasuries will collapse tomorrow, but before 30 years? I wouldn’t take that bet if I were you.