Daily Reckoning……An Interesting Question?

Posted By on December 23, 2009

That America’s precarious financial condition continues to dance on the sharp end of pin is a marvel of modern macroeconomics. Even after deconstructing the whys and wherefores of this marvel, it becomes no less marvelous. Essentially, America borrows and spends as much as it wishes by issuing as many Treasury bills, notes and bonds as it wishes. Somehow, no matter how many commas and zeros the US Treasury uses to quantify its auctions, the central banks of China, Japan, Russia and others continue to raise their paddles…no matter how miserably the dollar behaves.

Can this bizarre multinational financial arrangement continue forever? The obvious answer would be “no.” Nevertheless, this arrangement continues to operate without incident. For more than a decade, the largest central banks and sovereign wealth funds around the globe have been steadily increasing their holdings of US Treasury securities. Sure, some of these buyers – notably the Chinese – gripe publicly about the frailty of the US dollar, and yet, these buyers continue to buy…sort of.

As the chart below illustrates, foreign central banks have been ramping up their holdings of T-bills, as opposed to long-dated securities.

Short Term Yield Increase

In other words, foreign central banks, as a group, have been rolling off their long-dated holdings and parking their dollars in T-bills, despite the fact that T-bills yield almost nothing. Hmmm, why would they do that, we wonder? Are the buyers worried that inflation will kick up in the US? Probably. Are the buyers also worried about committing their capital to the US for a long time? Probably.

Whatever the exact motives that inspire these Treasury buyers to buy fewer long-dated Treasurys, we wonder how motivated they will be to refinance $1.6 trillion of maturing T-bills during the next three months, and $2.5 trillion during the next 12 months (in addition to fresh borrowing!).

“The faith-based, dollar-dependent monetary system is like a loaded pistol in front of a depressed man,” Bill Bonner remarked one year ago. “It is too easy for the US to end its financial troubles, Rueff pointed out, just by printing more dollars. Eventually, he predicted, this ‘exorbitant privilege’ will be ‘suicidal’ for Western economies.”

Hmmm…maybe it’s time to step out of the line of fire.

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