During our recent economic unpleasantness, the Federal Reserve used what was called ‘Quantitative Easing’ to keep rates low and therefore - in theory - to drive economic activity by making it easy to get money to launch businesses and other economic activities.
The rate on federal debt is largely - entirely? - market driven. That is, the DoT sells debt at auction. The come out and say, “We’ve got $100B worth of bonds to sell? We’re pricing them at X%. Any takers?” If there’s no takers they bump it up and see at what interest rate they eventually move.
With QE - and the associated QE2 - the Federal Reserve has basically said ‘We’ll take them!’ at whatever price the DoT opened at. Once up at something like $80B per month several months ago they started tailing it off at the rate of $10B per month until recently it was eliminated altogether.
So it’s not necessary for bond rates to be so low. But it’s the market that sets the rate. Until recently there was interference due to QE and QE2 but with that withdrawn there should begin to be some action in bond rates over time.
Note, however, that federal debt is traditionally at a very low rate of interest due to its security. It’s a place to hide money while an investor finds something more profitable/risky. But that security means low rates. So even with an openly floating rate I’d be very surprised to see the 5-year note get above 3% anytime in the next 10 years.
To understand we have to know there is a market for USA sovereign debt, and the buyers can buy either the new issuances or on the secondary market.
to understand the impact of the idea of the China selling huge amounts of their holding of US bonds, it is needed to understand how this may impact the demand for the US bonds, as it will not be stable - which is fixed, but will change against the economic situation. In fact the the Euro crisis would seem to tell us that if an action was thought to be soley driven by the Chinese for the Chinese reasons, the demand for the US bonds might increase as the safe haven, if it a case that is driven by a chinese crisis, economic ou political.
It is not thinkable in reality that the Chinese central bank would be so incompetent to engage in a brutal and massive sale of their holding of the US bonds as it would hurt them more directly than the US and would be illogical.
this is a completely false statement and analysis.
You do not understand the seperation of the legal entity.
My company owes a repayable debt to me, which I am also a owner in. Do I owe a debt to myself? yes, in a way but there are other owners in the company. It is the legal entity that is owing a debt to me. It is a debt owed. If it were a single owner company, what we call an SARL AU it would still be a debt, but since I would be on both sides, myself as the company could be nice to myself as the natural person, but it is still a debt and if one is going before the court, it is treated in this way.
What that would set up is a rise in issue price, nothing more. It would go something like this:
China: Hey everyone! We have 1.3T worth of US debt we want to sell.
World: What’s the rate on that? Why do you want to sell it?
China: The average rate is 1%. We’re selling because we think the US bites ass and we want to hurt them. They’re dicks.
World: Huh? Well, OK. I’ll buy all $1.3T of it.
China: GREAT!
World: I’ll pay you $750B for it.
China: What? Fuck you!
World: Good luck moving it then.
US: OK, we’ll offer our next round at 1.5%. Any takers?
World: I’ll take it.
It’s not that China attempting to sell US debt wouldn’t be inflationary, but it would be so pretty much to the point that buying US debt FROM the US was a better buy. So all the DoT would have to do is beat the interest rate available on Chinese holdings unless China was willing to take an enormous loss on the debt they hold.
Well, a very large part of the US debt is owed to Americans. If you have US bonds under your mattress, the US government owes you money. It’s still a debt, even if you’re American too. Unless you consider what you own as “common wealth”, and I assume you don’t. At some point, the US government will have to raise taxes or issue more debt to reimburse you and other Americans. It’s not completely neutral.
Although that internal debt is indeed of much less relevance. That’s why nobody cares much about the giganormous Japanese debt because 95% of it is owed to Japanese citizens/banks/companies.
Well, I was assuming that China was willing to take an enormous loss. You’re scenario assume that either :
China in fact doesn’t sell the debt (or at least not much of it) because she doesn’t want to lose money, but then nothing happens, and the scenario proposed was China actually selling the debt.
The market can absorb 1 trillion of debt overnight with only a reasonnable change in interest rates (say, they go to 5%). And that other debt holders (or simply dollar holders) don’t panic, too.
Or more succinctly than Jonathan Chance’s statement: For China to be *able *to sell all its bonds, someone must be willing to buy them, which implies the market for them is fine.
The bears have been expecting hyperinflation in the US at least as long as the Kenyan has been in office, and in fact we’re actually struggling to avoid deflation.
Even assuming the Chinese would be willing to take the financial beating associated with selling all of their debt (and what are they going to do with the money they raise?), considering that the US bond is current the world’s safe haven (and people are actually accepting negative interest rates on the shortest term debt), why do you think the rates would jump that much?
The financial world loves US bonds - I think it is just as likely that rates would jump 400% to 500% - which is a lot, and would put rates in the 8-10% range. And even at that, the Fed could always intervene again.
Which is why this is less an economic action and more of a political action. Which then becomes utterly unpredictable in terms of who would and wouldn’t be willing to buy those bonds.
In effect, it becomes and equation of ‘at what discount does the effective Yield-to-Worst’ outpace the rate at which the US is willing to issue bonds?’ That’s a complex calculation when it comes to economic warfare, which is absolutely what this would be.
In that sort of environment, a pre-emptive “Don’t buy that debt! We won’t honor it!” from the US would be disruptive, but it likely wouldn’t be as disruptive as allowing the Chinese government to manipulate US interest rates to that extent.
Not to mention that China would have to be in extremis to take such a loss. Removing $500B from their balance sheet isn’t something to do lightly when the entire nominal Chinese GDP is somewhere between 8.5 and 9.3T (sources vary). In effect, it would hammer Chinese ability to move their own holding around by making them a larger credit risk. Suddenly something like 8% of their GDP vanishes overnight. Unfun for them.
Yes, in theory this can happen. The main problem with this is when the US Government attempts to borrow money on the international money markets the next day. Having defaulted on the money due to China any subsequent lender to the US Govt will demand a return of 20% instead of 2-3%. They will not lightly risk lending to a country that so easily defaults on its debt.
What happens to the Chinese economy when the Chinese people wake up one morning and read in the newspapers that the Chinese government has just taken a big pile of US dollars and set it on fire?
The point of holding that debt is that it can be used to buy stuff in the future. Setting your money on fire–or selling it at a steep discount–means that all that money you’ve saved over the decades of hard work and privation is now gone.
China’s economy depends on being able to sell exports around the world. What happens when you’re biggest customer suddenly finds itself unable to buy your export goods?
I mean, the United States could crash China’s economy tomorrow, simply by slapping a 1000% tariff on all goods imported from China. China would implode, or explode, or both at the same time. Of course, we’d be screwed by this, since our economy depends on imports from China. But hey, China would be equally screwed, and if the point is to engage in economic warfare with China without regard for how bad it would hurt us, then they’re screwed, and it doesn’t matter that we’re screwed, because for some reason we don’t care.
As for the notion that during a war or political crisis with China, we’d be screwed because they hold 1.3 trillion in T-bills, that doesn’t make any sense. What has happened is, the US has bought 1.3 trillion dollars worth of goods from China, and sent them 1.3 trillion dollars worth of IOUs. The goods have already been shipped. If we’re in a war against the, they’re not going to be able to repossess the goods that are now in the US just because we ripped up those IOUs. If you lend a million dollars to a guy who spends the money and refuses to pay you back, what are you supposed to do? Call the cops. Except in the case of countries there are no cops. You have to MAKE him pay you back somehow. How do you do that? It’s not easy. History is littered with examples of sovereign states who borrowed money from various people, and then decided not to pay the debt back. This was a favorite tactic of monarchs–borrow millions from private financiers to pay for a war, and then when the war is over throw the financiers in prison and declare the debt void.
Oh yes, this makes people less likely to lend you money in the future. But the future is the future, and eventually people forget and decide that lending money to the king is safe as houses, after all the king can pay you back easily by raising taxes or with loot from the war. Turns out that doesn’t always happen. The king only has to pay you back if he decides to pay you back.
Eh, I’m not sure defaulting because another country declared war on us is “easily defaulting” on our debt. People in countries who might also go to war against us might want a higher interest rate, but generally speaking, I don’t think there’d be a large increase in the perceived risk of default.
What about more recent cases of war, not involving kings? What happened to US sovereign debt owned by Germany during I and II? To US debt held by Iraq during the recent war?
Hmmm…no. There will always be someone willing to buy junk bonds for pennies to the dollar.
Again the hypothetical was “China and others sell all their bonds”. Not “they sell them at an advantageous price, and if they can’t do that they don’t”.
It’s whatever the market interprets it to be. Permanently defaulting on a trillion dollar debt to China because of some assumingly temporary war is still default. If the US decides to default on country A because of war they can just as easily decide to default on country B because of something else entirely(this is how the market would view it imo). The US is currently seen as a safe haven financially, any default will likely result in vastly increased interest rates. The same general scenario would go for any country. Default leads to increased rates demanded on further loans. I cant guarantee it would go to 20%, it may go higher or lower, but it will increase. Most Southern European countries have run into real trouble when interest on debt reaches 7% or so. It’s probably around this figure for the US too. Increased rates on US debt really is not an option for the US anytime soon, at least not an option that ends well.
People that buy bonds are concerned with the risk of default on those bonds, not the risk for some other bonds held by someone else. A default due to war with one particular country would pretty clearly be idiosyncratic to that case, and not a reflection on the US’s general ability or willingness to repay its debts.
(of course, in the real world, a war with China would have a lot of other effects that would affect peoples perception of the US’s ability to pay its debts, both for good and for ill. But we’ll assume the hypothetical Sino-US war happens in a vacuum. )
I asked this a while ago, and didn’t get much of a response. I don’t think its come up. Germany prior to WWI and WWII was a net debtor to the US (Hitler repudiated those debts during WWII, and Germany finally paid them off after re-unification). And in general, the countries the US has gone to war with have been debtor nations.
The closest case I could find is the US repudiation of Confederate debts after the Civil War, but that’s obviously not the same thing.
I think a war between the U.S. and China is extremely unlikely because of their closely-interlinked economies (and other reasons), but IIRC the same argument was made before 1914 about the European economy. Sometimes governments just do things that are manifestly not in their best economic interest.
Putting aside the military consequences of war. War’s are temporary. Most of them last a few years or so. Delaying the payment of debt to China could be seen as understandable. Again, this comes with caveats such as whether the international markets viewed such an act as in bad faith, or, as a slippery slope. It would unlikely increase lenders trust in the US. However, permanently defaulting on the debt would imo be seen as an untrustworthy act. Trust and confidence being the main issues on someones willingness to lend.
I think we are both assuming different things here. Your assuming the US Government acts in a financially prudent way, and they will always commit to paying off debts to countries they are not at war with. Im assuming politicians are sob’s who will in years ahead try find a pretext for not paying the debt if they can get away with it. The ability of the US to borrow at low interest rates would depend on whether the market takes your view or mine.
It’s also worth pointing out huge swaithes of the world have “troubled” relations with the US. How likely are Russians, Pakistani’s, Mexicans, Saudi’s, and others willing to lend to the US when they have just seen the US default on China? These countries may not hold huge amounts of US debt, but they will be a relatively large part of the market, a larger part once the Chinese have entirely stopped lending to the US.
In a US-China spat, it’s very unlikely that the US would characterise or structure whatever anti-China steps it might take as a default on bonds held by China, for the reason already pointed out - if the US can default on any bond because they don’t like the holder, then the value of every US bond is diminished. Maybe next month the US government won’t like you. And even if you’re confident that that will not be the case, the pool of people interested in buying your bond before maturity is now a good deal smaller. China’s not buying, and neither is anybody else who thinks they might be villain-of-the-month in Washington any time soon.
I suspect what the US would do is sequestrate Chinese assets in the US - which would, of course, include all US bonds held by China. The bonds would still pay interest, and they would still be redeemed on maturity, but instead of those payments going to China they would go into the account of a US-government-appointed “receiver of enemy property” (or similar title), to be held there pending the final resolution of the US government’s spat with China. Maybe they’ll eventually be paid to China; maybe they’ll be set off against some Chinese government obligation to the US; maybe they’ll be seized as war reparations; maybe something else. But the integrity and reliablity of the US government’s bonds will not be called into question.
This still causes the US government some problems. You don’t have China dumping its US bonds in the secondary market, but you do have China’s bonds maturing and having to be repaid, and the dollars for this must be found. Normally they are found by issuing new bonds, but of course China isn’t buying, so interest rates may have to be jacked up to attract enough extra buyers, or extra demand from current buyers, to balance the books. Or taxes have to go up. Or expenditure has to go down. Any of these is painful, but not as painful as if the US government has completely trashed the reputation of its own bonds.