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Weekend Videos

Just got back to blogging late Friday evening. Had to entertain my relatives from Canada who are in. Like the Irish a couple of weeks ago, they shopped liked it was Christmas in July to take advantage of the weaker dollar. I know one thing for sure. Foreigners sure love our “strong dollar” policy…

“Oil Crisis”
Becky Quick
CNBC, July 18, 2008

From the CNBC website:

The House may vote on releasing oil from the strategic petroleum reserve, with Senate Majority Leader Harry Reid and CNBC’s Becky Quick.

You can view the 3 minute 18 second video here.

Note to Congress- there is no quick-fix for the energy crisis. I’m starting to consider donating funds to Jim Puplava’s proposed program, “No Congressman Left Behind.”

Apparently, it’s a non-issue now anyway, seeing that after oil prices suffered their biggest weekly drop ever, Yahoo! Finance asks tonight, “So is it time to declare the energy bubble popped?” By the way, the Associated Press is reporting that terrorists are trying to enter the United States with European Union passports. Good thing Congress wants to deplete oil stockpiles meant for a national emergency. Like a major terrorist attack, for example. If you think 9/11 was a one-off event, I have a bridge that spans the East River out in NYC that I can sell you for a really good price…

“Is government clueless about economy”
Jim Jubak
MSN Money, July 18, 2008

From the MSN Money website:

Washington is talking us into a deeper crisis. Neither the President nor Congress gets it: When you owe as much as the US does, keeping your overseas creditors happy is the most important thing, says Jim Jubak.

You can view the 4 minute 7 second video here.

Jubak said in the segment:

The Saudi government has gone into serious discussions about taking its currency off the dollar peg.

“Christmas In July”
The Dandy Warhols, “Little Drummer Boy” (1995)
YouTube Video Link

Hooray For Stocks

Curious about how the U.S. stock market fared in 2007? I came across the following data in the Wall Street Journal earlier today:

Dow Jones Industrial Average- up 6.4%
DJ Wilshire 5000- up 3.9%
DJ World (excluding U.S.)- up 11.8%
Amex Composite- up 17.2%
Nasdaq Composite- up 9.8%
NYSE Composite- up 6.6%
S&P 500- up 3.5%
Russell 2000- down 2.7%
Value Line (Geometric)- down 3.8%

This is the actual order of the indexes as depicted in the Journal. I like how the DJIA is at the top of the heap and the S&P 500 is tucked away in the pile. Is the Journal somehow implying that we should use the DJIA’s 6.4% return as “the” benchmark? According to Investopedia:

The main drawback of the DJIA is that it only contains 30 companies. The S&P 500 improves on the DJIA in this respect by including 500 companies. It is increasingly seen as the benchmark of the U.S. stock market. In fact, the performance of most equity managers is pegged against the S&P 500.

From the data, the S&P 500 gained 3.5% in 2007. A 3.5% return is nothing to write home about. I suspect a few investment advisors will be glossing over this fact when meeting with prospective clients in 2008.

Putting last year’s stock market performance into perspective, Nouriel Roubini, a former Treasury Department director under the Clinton administration and head of Roubini Global Economics in New York, noted the following in his post “2007: Cash Outperformed the Stock Market” from yesterday:

In 2007 cash (in the form of holdings of short-term Treasuries or money market funds) outperformed the stock market in the US. The year ended with a bearish note as all major indices down on Monday.

The broad index of the US stock market, the S&P500, ended the year up a mediocre 3.5%: that is less than the inflation rate for the year (that was above 4%) and that is less than holding a money market fund or a basket of short-term US Treasuries.

Commodities, anyone?

Paulson Predecessor Says U.S. Recession Likely

In Sunday’s Financial Times (UK), former U.S. Treasury Secretary Lawrence Summers said that the odds now favor a U.S. recession that will slow growth significantly on a global basis. Summers, who served with the Clinton administration and now teaches at Harvard University in addition to serving as a managing director at hedge fund D.E. Shaw Group, concluded that the U.S. economy will stall out, based on the following:

1. The U.S. housing slump marches on.

Several streams of data indicate how much more serious the situation is than was clear a few months ago. First, forward-looking indicators suggest that the housing sector may be in free-fall from what felt like the basement levels of a few months ago. Single family home construction may be down over the next year by as much as half from previous peak levels. There are forecasts implied by at least one property derivatives market indicating that nationwide house prices could fall from their previous peaks by as much as 25 per cent over the next several years.

2. The U.S. financial sector will be rocked— hard.

Second, it is now clear that only a small part of the financial distress that must be worked through has yet been faced. On even the most optimistic estimates, the rate of foreclosure will more than double over the next year as rates reset on subprime mortgages and home values fall. Estimates vary, but there is nearly universal agreement that – if all assets were marked to market valuations – total losses in the American financial sector would be several times the $50bn or so in write-downs that have already been announced by big financial institutions. These figures take no account of the likelihood that losses will spread to the credit card, auto and commercial property sectors. Nor do they recognise the large volume of financial instruments that depend for their high ratings on guarantees provided by credit insurers whose own health is now very much in doubt.

3. Credit, necessary for economic expansion, will become tougher to come by.

Third, the capacity of the financial system to provide credit in support of new investment on the scale necessary to maintain economic expansion is in increasing doubt. The extent of the flight to quality and its expected persistence was powerfully demonstrated last week when the yield on the two-year Treasury bond dropped below 3 per cent for the first time in years. Banks and other financial intermediaries will inevitably curtail new lending as they are hit by a perfect storm of declining capital due to mark-to-market losses, involuntary balance sheet expansion as various backstop facilities are called, and greatly reduced confidence in the creditworthiness of traditional borrowers as the economy turns downwards and asset prices fall.

Add the following:

Then there are the potentially adverse effects on confidence of a sharply falling dollar, rising energy costs, geopolitical uncertainties especially in the Middle East, or lower global growth as economic slowdown and a falling dollar cause the US no longer to fulfill its traditional role of importer of last resort.

And you have the recipe for an economic recession in the United States. Summers said:

Even if necessary changes in policy are implemented, the odds now favour a US recession that slows growth significantly on a global basis. Without stronger policy responses than have been observed to date, moreover, there is the risk that the adverse impacts will be felt for the rest of this decade and beyond.

Chinese Officials Torpedo Dollar

The troubled U.S. dollar sank to new lows today, partly because of comments made by Chinese officials at a conference in Beijing. Cheng Siwei, vice chairman of the Standing Committee of the National People’s Congress, said that China should shift more of its $1.43 trillion of currency reserves into “stronger currencies,” such as the euro, to offset “weak” currencies like the dollar. Xu Jian, a central bank vice director, added that the dollar is “losing its status as the world currency.” Earlier today, the U.S. currency fell to a record versus the euro and is at its weakest level since 1981 against the pound. The greenback also declined to its lowest level against the Canadian dollar since the end of a fixed exchange rate in 1950 and stands at a 23-year low against the Australian dollar.

Larry Smith, who manages $400 million as chief investment officer at Third Wave Global Investors, told Bloomberg today that, “The big issue on any currency is if its rate of depreciation is so fast that it scares away all capital, and the announcement that we heard from China sort of feeds those fears.” Dustin Reid, foreign exchange strategist at ABN Amro in Chicago, told the Wall Street Journal today that statements from the Chinese officials remind us of the possibility that China and other countries with huge dollar reserves could start diversifying out of greenbacks heavily, starting in 2008. According to MarketWatch this morning, Vincent Chaigneau, the head of fixed-income and foreign-currency strategy at Societe Generale, wrote in a note to clients that:

As if ballooning U.S. credit/housing crunch data, back-to-back Fed cuts and soaring oil prices weren’t enough to stun the U.S. dollar, now we have the specter of central-bank reserve asset diversification out of U.S. dollars to contend with.

It should be noted that Chinese investors have reduced their holdings of U.S. Treasuries by 5% to $400 billion in the five months prior to August, the last time figures were released. China Investment Corp., which manages the nation’s $200 billion sovereign wealth fund, said last month it may deploy more of the nation’s reserves for investment purposes.

Sunday Edition: October 21, 2007

Something Wicked This Way Comes
It was only a matter of time before prices at the pump went up with oil hovering around $90. According to the nationwide Lundberg survey of about 7,000 gas stations, the national average for self-serve regular unleaded gas was nearly $2.80 a gallon on October 19, up 4.92 cents per gallon in the past 2 weeks. Survey editor Trilby Lundberg told Reuters this weekend that:

While gasoline prices moved up just under a nickel in that period, crude oil prices are up the equivalent of 18 cents per gallon. That missing 13 cents and more will probably turn up at the pump and soon because it represents margin squeeze over months for refiners, jobbers and retails — those who make, deliver and sell gasoline.

At $2.80 a gallon, gas prices are 60 cents more than at this time last year. The all-time high of more than $3.18 was reached back on May 18, 2007. High gas prices act as a drag on the economy. The more they rise, the more consumers have to spend on fuel and the less they have to spend on other goods and services, which drives the U.S. economy. Lundberg noted that the average price is likely to exceed $3 per gallon in coming weeks.

G-7, G-Whiz
Talk about sending the wrong message. The Group of Seven (G-7) finance chiefs ended their weekend meeting without offering verbal support for the U.S. dollar.
The G-7 consists of the United States, Japan, Germany, France, Britain, Italy and Canada. G-7 finance ministers meet several times a year to discuss economic policy. While the officials urged China to speed up appreciation of the yuan, it did not comment on the prevailing dollar weakness against other currencies, most notably the euro. Analysts have said this silence was largely expected, since U.S. leaders are hoping a weakened currency will boost American exports and reduce the massive current account deficit. Yet, should the decline in the dollar’s value continue to accelerate, foreign investors may sell their dollars and move their cash into other markets where interest rates are rising and whose economies appear better off. The American economy will suffer. An Associated Press article from September 25 talked about such a scenario:

If foreigners’ buying habits change, that could have a broad impact on financial markets- and U.S. consumers, too. For instance, if they sell their U.S. Treasury holdings, or don’t buy new government bonds or notes, then Treasury prices will go down and yields will go up. That will likely send mortgage rates higher since they are pegged to the 10-year Treasury note. That could unravel any good that has come from the Fed’s rate-cutting action and put the economy in a precarious spot. It makes you wonder why this administration isn’t doing more- or anything- to help the dollar.

Currency traders interpreted the silence as meaning official attempts at propping up the greenback are unlikely, according to Reuters earlier today. Michael Woolfolk, senior currency strategist at The Bank of New York Mellon, said “The G7’s statement effectively gives a green light to continue selling the dollar.” Traders may refocus this week on slower economic growth in the U.S., high oil prices, and the housing slump. Phyllis Papadavid, currency strategist at London-based Societe Generale, told Reuters that, “There’s acknowledgment that the fundamentals in the U.S. economy aren’t up to scratch at the moment, and in that regard the dollar isn’t in the clear.”

The greenback has been falling for more than 5 years now, and recently hit a new low against the euro and 26-year low against the pound. While the U.S. dollar lost 8% of its value last year against a basket of foreign currencies, it is already down another 7% to date. Still, Washington claims to support a strong dollar policy. On October 16, U.S. Treasury Secretary Henry Paulson said:

In terms of the upcoming G7 … the strong dollar is in our nation’s interest. I have said repeatedly that, and currency values should be determined in competitive markets, based on underlying economic fundamentals.

Actions speak louder than words, Mr. Secretary.

Follow Through
In a post from last Thursday, I talked about how overseas private investors sold a record amount of U.S. securities in August. According to the U.S. Treasury Department earlier in the week, the total holdings of equities, notes, and bonds fell a net $69.3 billion, after an increase of $19.5 billion in July. The outflow from U.S. assets was a record high and the first since the financial market crisis back in 1998.

You may be interested to know that former Federal Reserve Chairman Alan Greenspan said in a speech earlier today that the recent performance of the U.S. dollar may be tied to overseas investors unwilling to buy more U.S. debt. Speaking from Washington, D.C., Greenspan said, “Obviously there is a limit to the extent that obligations to foreigners can reach.” According to Bloomberg, the popular, yet controversial, economist noted that the dollar decline may be “an indication America is approaching this limit.”

Parting Shot
Back on July 2, I wrote about U.S. Treasury Secretary Henry Paulson and his views on the troubled U.S. housing sector:

The former chairman of Goldman Sachs stated that the downturn in the housing market is “at or near the bottom. It’s had a significant impact on the economy. No one is forecasting when, with any degree of clarity, that the upturn is going to come other than it’s at or near the bottom.”

In my August 1 post, I talked about how Secretary Paulson felt that housing’s economic fallout was contained:

According to Reuters, “Paulson added that he did not see anything that caused him to reconsider his view that the economic damage from the housing correction was ‘largely contained,’ despite losses in a number of financial institutions and a long period for subprime issues to move through the economy.”

Fast forward to October 16. The former Goldman Sachs chairman had this to say to Georgetown University’s law school:

But let me be clear, despite strong economic fundamentals, the housing decline is still unfolding and I view it as the most significant current risk to our economy. The longer housing prices remain stagnant or fall, the greater the penalty to our future economic growth.

Good grief…

Have a wonderful week,

Christopher E. Hill
Editor
editor@boom2bust.com

Foreign Investors Dump U.S. Assets

In the midst of the credit market upheaval, overseas private investors sold a record amount of U.S. securities in August. According to the U.S. Treasury Department on Tuesday, the total holdings of equities, notes, and bonds fell a net $69.3 billion, after an increase of $19.5 billion in July. The outflow from U.S. assets was a record high and the first since the financial market crisis back in 1998. The previous record decline of $21.2 billion took place in March 1990.

The monthly net Treasury International Capital System (TIC) flows, which include non-market flows, short-term securities, and changes in banks’ dollar holdings, revealed an outflow of $163 billion in August, compared with an inflow of $94.3 billion in the prior month. Private investors overseas led the outflows, selling a net $141.9 billion in U.S. assets in August.

According to the Wall Street Journal yesterday, official holdings are of greater importance to the foreign-exchange market, given their massive size. Foreign official holdings in Treasuries fell by a net $29.7 billion. The Journal noted that the TIC data “gave no indication that central banks are shunning the greenback in any significant fashion.” Yet, the two largest holders of U.S. Treasury securities reduced their holdings in August. Japan, the largest holder of U.S. government debt, decreased its holdings by $24.8 billion (4%). China, the second-largest holder of Treasuries, lowered its holdings by $8.8 billion (2.2%).

The sell-off of U.S. assets came at a time when China, South Korea, and Qatar joined Singapore and Norway in setting up sovereign wealth funds to invest excess foreign exchange reserves from export revenue to improve returns. Robert Rennie, chief currency strategist at Westpac Banking in Sydney, told Bloomberg yesterday that, “Asian central banks are becoming more conscious of increasing returns. We’re seeing moves to create sovereign wealth funds, which by definition suggest a structural shift away from Treasuries.”

Foreign Investors Worried About U.S.

From the Persian Gulf to Beijing to Zurich, there is increasing skittishness about the health of the U.S. economy and the wisdom of our economic policies. Bernanke’s kowtowing to the powers-that-be on Wall Street did nothing to allay those fears.

-Dean Calbreath, San Diego Union-Tribune financial columnist, September 23

In the not so distant past, overseas investors gladly acquired American dollars and financial assets. However, more and more evidence is surfacing that these investors are starting to question the wisdom of investing in the United States. The decision by the Fed last week to cut its benchmark interest rate by a half point to 4.75%, and the subsequent downward pressure on the U.S. dollar that it generated, raised eyebrows overseas. While the move was intended to calm the recent financial turbulence in the United States, it also caused foreign investors to sell dollars and move their cash into other markets where interest rates are rising and whose economies appear better off. Earlier today the dollar index, which measures the greenback against a basket of six currencies, touched a new 15-year low of 78.213. Jim Awad of W.P. Stewart Asset Management told the Wall Street Journal on September 23, “Washington wouldn’t mind an orderly [dollar] decline — [but doesn’t] want a headline emotional decline. That would force foreign investors to unload dollar-denominated assets and tie the Fed’s hands [on] interest rates.” So far this year, the dollar is down 8% against a weighted basket of major currencies, according to the Federal Reserve. Dean Calbreath of the San Diego Union-Tribune remarked on September 23 that:

The U.S. dollar has plummeted to the extent that- if you judged our economy by the euro rather than the dollar- it is as if we have been in a recession for the past seven years. Judged by euros, the Dow Jones industrial average is still well below the highs it hit in 2000.

In fact, Jack Ablin of Harris Private Bank noted in the Wall Street Journal last week that while growth in the S&P 500 is up almost 8% in dollars year-to-date, it is only a miniscule 1% when denominated in euros.

Prior to the Fed’s action on interest rates, the evidence already existed that overseas investors were shying away from U.S. financial assets. In July, foreigners sold a net $9.4 billion in U.S. Treasury bonds, one of the largest sell-offs on record. As of last year, foreigners held 45% of U.S. Treasury bills, 33% of U.S. corporate bonds, and 19% percent of U.S. agency notes. Declining foreign investment in the United States could have a broad impact on financial markets and American consumers. An Associated Press article from September 25 discussed what might happen:

If foreigners’ buying habits change, that could have a broad impact on financial markets- and U.S. consumers, too. For instance, if they sell their U.S. Treasury holdings, or don’t buy new government bonds or notes, then Treasury prices will go down and yields will go up. That will likely send mortgage rates higher since they are pegged to the 10-year Treasury note. That could unravel any good that has come from the Fed’s rate-cutting action and put the economy in a precarious spot. It makes you wonder why this administration isn’t doing more- or anything- to help the dollar.

For years the enduring myth among foreign investors had been that it was profitable to hold on to U.S. dollars and financial assets. However, faced with the harsh reality of seeing their holdings decrease in value and receiving a lower rate of return, I can understand them having second thoughts about partnering with Uncle Sam.

Consequences Of Today’s Fed Cut

Earlier today the Federal Reserve cut its overnight interest rate target by half a percentage point to 4.75%, the first reduction in four years. The statement released by the Fed indicated that the move was carried out to “forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions of financial markets and to promote moderate growth over time.” Not surprisingly, this resulted in the Dow Jones Industrial Average’s largest one-day jump since October 15, 2002, and biggest percent rise since April 2, 2003, finishing up 336 points, or 2.5%, at 13,739.4. Many applauded the Fed’s move, believing it will pre-empt major weakness in the U.S. economy. However, a few critics stepped forward and pointed out the drawbacks of today’s action. Art Hogan, chief market strategist at Jefferies & Co., told MarketWatch today:

The market is acting like [Federal Reserve Chairman] Ben Bernanke just cured cancer, and I can tell you, he didn’t. This is typical of the knee-jerk reaction to what we perceive to be good news.

As the result of today’s Fed cut, look for negative effects on domestic investments tied to interest rates, on foreign investment in the United States, and on the value of, and confidence in, the U.S. dollar.

Lower rates will hurt those individuals whose incomes are tied to short-term interest rates on money markets and savings. Lower rates=less income=less consumption=slowing economy. Carl Steidtmann, Deloitte Services’ chief economist, told MarketWatch, “That’s the downside for those households that have financial assets tied to the interest rates and are generating cash off of that.”

Another, more serious risk to the U.S. economy, is the potential decline of foreign investment here as the result of today’s action. Lower rates would make some U.S. investments, such as government-issued treasuries, less attractive to foreigners. David Wyss, chief economist for Standard & Poor’s, and Edward Leamer, director of the UCLA Anderson Forecast, told CNN Money today that a significant drop in foreign investment would be a big problem for the U.S. economy because that flow of funds has been the key to keeping long-term rates low. “Last year we had $1 trillion come in net foreign investment, most of it into the bond market, and most into private bonds, not Treasuries,” said Wyss. “If that money stops coming in, that’s going to be a big increase in borrowing costs.”

Should foreigners hesitate to invest in the United States, the decline in the value of the U.S. dollar could get even worse. American consumers could see higher-priced imported goods and a reduction in their spending power. Rollback prices at Wal-Mart would be a thing of the past. Speaking of the dollar, it dropped to a new record low against the euro and also fell against most of its other major counterparts on Tuesday. The dollar index, which tracks the greenback against a basket of six major currencies, broke below a 15-year low and dropped to 79.240, down from 79.645 before the announcement. The U.S. currency also hit a fresh 30-year low against the Canadian dollar. Gold was also a beneficiary of declining confidence in the U.S. dollar, as the precious metal continued its impressive run and moved past $735 an ounce in electronic trading late today, reaching its highest level since 1980. Peter Spina, an analyst at GoldSeek.com, discussed the rate cut with MarketWatch and said that “the decision is another nail in the coffin for the U.S. dollar and will further extend the gold price rally.”

China’s Nuclear Option, Part 1

It started back on July 26. The U.S. Senate’s Finance Committee overwhelmingly approved legislation requiring the U.S. Treasury Department to negotiate with countries possessing “fundamentally misaligned” currencies. It would also impose trade penalties on countries that fail to take action, taking complaints to the World Trade Organization if necessary. The committee approved the legislation in a 20-1 vote. While the legislation doesn’t mention China by name, it is surely directed at them and is the result of bipartisan anger on Capitol Hill which claims the yuan’s peg to the U.S. dollar leaves the currency undervalued, to the detriment of American exporters. “There is no doubt that China and other nations have been undervaluing their currency to give themselves an advantage,” said Senator Lindsey Graham (South Carolina) in MarketWatch on July 26. “For too long the game has been rigged against American business. Working together we will change currency practices to put American business on a level playing field.”

This past Tuesday, Senator Max Baucus of Montana announced that the U.S. Congress will pass currency legislation to ease U.S.-China trade imbalances regardless of efforts by the Bush administration to address the problem. Senator Baucus said he appreciated U.S. Treasury Secretary Henry Paulson’s work to persuade the Chinese government to appreciate its currency, the yuan, but said such efforts were not enough. According to Reuters, Baucus declared, “No country out of the goodness of its heart ever lowers a trade barrier, ever… We in the Congress have to help China do what it knows it should do.”

Enter China. The Telegraph (UK) reported on Wednesday that two Chinese officials at leading Communist Party bodies have said that Beijing may use its $1.33 trillion in foreign exchange reserves (with $407 billion in U.S. Treasuries)
as a political weapon to counter pressure from U.S. legislators. Changes in Chinese policy are often announced through key think tanks and academies. Xia Bin, finance chief at the Development Research Center (which has cabinet rank), commented last week that Beijing’s foreign reserves should be used as a “bargaining chip” in talks with the United States. He Fan, an official at the Chinese Academy of Social Sciences, went even further yesterday, letting it be known that Beijing had the power to set off a dollar collapse if it choose to do so. Fan said:

China has accumulated a large sum of U.S. dollars. Such a big sum, of which a considerable portion is in U.S. treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency. Russia, Switzerland, and several other countries have reduced their dollar holdings. China is unlikely to follow suit as long as the yuan’s exchange rate is stable against the dollar. The Chinese central bank will be forced to sell dollars once the yuan appreciated dramatically, which might lead to a mass depreciation of the dollar.

Such action could trigger a dollar crash and larger U.S. financial crash at a time when the U.S. currency is already breaking down through historic support levels. Simon Derrick, the Bank of New York’s chief currency strategist in London, said the comments were a message to the U.S. Senate as legislation is prepared for the Autumn session. “The words are alarming and unambiguous. This carries a clear political threat and could have very serious consequences at a time when the credit markets are already afraid of contagion from the subprime troubles,” he said.

However, other financial analysts who spoke to the Washington Post today play down the threat of China using its “nuclear option,” as it’s sometime called. According to the Post, should China dump the dollar, thereby lowering its value, it would hurt its own pocketbook because it is such a large investor. “There would be turmoil in the financial markets… It’s not really a credible threat,” said Menzie D. Chinn, professor of economics at the University of Wisconsin. Even Treasury Secretary Paulson said He’s comments were “frankly absurd,” in a CNBC interview yesterday.

Peter Schiff, president of Euro Pacific Capital and author of Crash Proof: How to Profit from the Coming Economic Collapse, says there’s more to the currency issue than what’s made public. In his book he argues:

Hardly a month goes by without another U.S. government official or elected politician calling on the Chinese government to appreciate the yuan, which is currently pegged to the U.S. dollar. Such public browbeating is pure political grandstanding. It’s all a bluff. Privately, I am sure, we are begging the Chinese not to float their currency. China is the biggest buyer of U.S. Treasury securities, and the Chinese do it to defend the currency peg. They are also the biggest suppliers of low-priced consumer goods to Americans. Why on earth would American officials and politicians demand that China increase both consumer prices and interest rates in America? The result would surely be a severe recession.

Yet, the legislators carry on with their threats. Fortune reported that on Tuesday night Illinois Senator Barack Obama spoke before an AFL-CIO audience and said he would “take [China’s leaders] to the mat” for “manipulating their currency,” adding that huge U.S. deficits, financed in part by the Chinese, must end. “It’s pretty hard to have a tough negotiation when the Chinese are our bankers,” the Senator told a cheering crowd.

China has amassed a fortune through exporting cheap consumer goods to the United States and by purchasing U.S. securities to defend its currency peg, thereby keeping prices low. American consumers went ahead and bought inexpensive goods “Made in China” at our local Wal-Marts, helping keep consumer prices low but effectively making the Chinese our bankers. Unfortunately, China, now flush with U.S. dollar assets, possesses a “nuclear option” where it can trigger a U.S. financial crash should push come to shove. It is all too apparent that China has the upper hand in this situation, lest I remind the Senators of this and one other fact:

Be careful not to bite the hand that feeds you.

China Sells U.S. Treasuries

Earlier today Bloomberg reported that in April, Chinese investors sold the most U.S. Treasuries in at least seven years. China sold a net $5.8 billion of Treasury securities, which is the first drop in holdings since October 2005. They held $414 billion of the $4.4 trillion in marketable Treasuries in April, making it the largest owner of U.S. debt. However, China’s actions to diversify its $1.2 trillion foreign exchange reserves, most of it in dollar-backed assets, may cause Treasury yields to rise and the U.S. dollar to fall. In March, China announced it was creating an agency to actively manage its reserves. “The old saying was ‘China would buy Treasuries come hell or high water’… The move to more active reserve management is going to spell trouble for Treasuries,” said Michael Gregory, a senior economist for BMO Nesbitt Burns in Toronto. Samarjit Shankar, global strategy director for the foreign exchange group at Mellon Financial Corp., told Bloomberg, “It’s part of the ongoing, gradual, long-term diversification story… It may not necessarily impact the daily market, but this does raise the concern about the dollar.” Bloomberg was the only major financial news outlet that picked up on this story. It will be interesting to see if China’s actions are the beginning of a trend to dump Treasuries.