China "dumping US debt" - please explain to me in the most layman terms possible

Factual Questions
21

But - the government spends money - to pay civil servants, pay Medicare bills, VA, buy fighter jets and aircraft carriers, etc. It also takes in assorted tax revenues. However, the federal government - the assorted departments - spend a lot more than the IRS collects; so to pay for that stuff, they also sell T-Bills, in a roundabout way - i.e. refinance the mortgage on the government. That borrowed money goes into federal accounts to help pay for all the things that the IRS revenue was not enough to cover. Essentially, the Fed sells bonds on behalf of the working government’s deficit.

Yes, the Fed can also “make up” money or electronic transfers. Basically it’s the keeper of loans and deposits for the entire banking system. Banks that need temporary liquidity get an overnight loan from the Fed. If the Fed says “ABC Bank, you now have a loan for an extra hundred million” everyone believes them. If the Fed buys the Treasury bills and says “Treasury, you now have an extra hundred billion” then everyone believes them. Standard rates may apply…

At least with the banks, the regulations are supposed to ensure the banks keep enough money at hand to cover eventualities, so that a bank does not need the Fed loan to stave off bank failure; so those loans to banks that add to the money supply are optional, and when the Fed needs to scale back they can safely make them more expensive (higher interest) with out crashing the system.

But both those sources are part of the money supply. If the money supply gets too big too fast, it causes inflation. Everyone is flush with cash, nobody discounts what they sell (or they raise prices) because a lot of entities seem to have plenty of money… People see all this money floating by and demand higher wages.

Places like Argentina, Zimbabwe, Nicaragua, Weimar Germany and post-Soviet Russia did not understand this (or did not care). When there’s too much money for the amount of goods in circulation, you get serious inflation. (And by contrast, when there’s too little money, you get deflation and depression, where when nobody has money, nobody can sell anything, prices drop.)

The goal of the Fed is to keep the money supply in the right range. With and without QE, they’ve actually done a pretty good job after the inflation of the 1970’s.

22

If someone dumps their US bonds for noticeably below fair market value, technically the US could just buy those up, saving money in the long run. (It then has to issue replacement bonds but those will be sold for more than what the US paid for the ones they just bought.)

While the Chinese could vet buyers to some degree, if they are selling off a lot of bonds they can’t be perfect, some buyers could be secretly fronting for the US.

(Note that during the later Clinton surplus era the US bought back high interest bonds and replaced them with lower interest ones. Saved the taxpayers quite a bit. So something sort of similar has happened before.)

23

Thanks for the replies.

3 more questions…

Are T-bills and Treasury bonds the same thing?

Is “buying and selling Treasuries” just T-bonds?

How are the bonds actually handled - a real paper document that some diplomat or banker has to sign - “Brazil agrees to buy ten billion dollars’ worth of T bonds, (sign on dotted line?)”

24

Technically a T-bill is a short term bond. Generally three months. Treasury notes go up to 10 years and treasury bonds go 20-30 years. There are some other similar items but those are the big three.

In practice, a layman can often refer to them all as T-bills or bonds and be ok.

And yes, everything is electronic now.

25

Nobody can cause serious trouble by threatening to “dump” Treasuries. Think of it like this. China accumulate $1 trillion because of its trade surpluses. This exists as data on whichever hard drives in the financial system keeps track of these matters. China exchanges these dollars for interest bearing Treasuries which get spent back into the US economy. If China sells them, it now has dollars again. The US dollar is a special case, being the reserve currency. The Federal Reserve can, if it wishes, monetize the debt. The Fed could buy ALL Treasuries and the banks, hedge funds, pension funds, etc. would then own non-interest bearing assets instead of interest bearing assets in their accounts. Think QE on steroids. Now, of course, the Fed collects interest on the Treasuries it owns from the US Treasury. At the end of the year, it remits its profits-interest minus expenses-to the Treasury. In recent years, it has been about $80-90 billion. Yes, that is actually how it works.