The Chinese are fed up with U.S. debt

The big news yesterday was that China was dumping its US Treasury debt. Behind this story is another story.

The government said Tuesday that foreign demand for US Treasury securities fell by the largest amount on record in December with China reducing its holdings by $34.2 billion.

The reductions in holdings, if they continue, could force the government to make higher interest payments at a time that it is running record federal deficits.

The Treasury Department reported that foreign holdings of US Treasury securities fell by $53 billion in December, surpassing the previous record of a $44.5 billion drop in April 2009.

The big drop in China's holdings meant that it lost the top spot in terms of foreign ownership of US Treasuries, dropping to second place behind Japan.

Japan also reduced its holdings of US Treasuries, cutting them by $11.5 billion to $768.8 billion in December, but that amount was still more than China's December total of $755.4 billion.

The $53 billion decline in holdings of Treasury securities came primarily from a drop in official government holdings, which fell by $52.3 billion. The holdings of foreign private investors fell by $700 million during the month of December.

For all of 2009, foreign holdings of US Treasuries dipped by $500 million. In 2008, foreigners had increased their holdings of US Treasuries by $456 billion as a global financial crisis triggered a flight to the safety of US government debt.

China is cutting back on US debt purchases. So is Japan. And so are the big bond funds, such as PIMCO, the biggest in the world. Who will buy US bonds?

Where will the US get the money it needs to squander on wars for the young and pills for the old?

The number of potential buyers is getting dangerously low...to the point where an auction of Treasury debt could fail for lack of interest.

What this seems to mean...on the surface...is that treasury yields will rise. Less demand. More supply. Prices fall. Yields rise. In fact, that is what seemed to be underway yesterday. Prices on 30-year Treasury debt fell.

If yields rise significantly you can say goodbye to any hope of a recovery. Rising yields make it harder for investors and businesses to make money. New projects will be cancelled; new workers will be fired even before they are hired, and investors will move their money out of investments that are ‘risky.’

Especially hard hit will be Japan. Japan will slip suddenly into inflation...and then hyperinflation.

Yesterday also brought news that the feds’ stimulus program has been a big success. Barack Obama says so. The New York Times, via columnist David Leonhardt, says so. So does the Financial Times’ lead economist, Martin Wolf.

The feds spent a lot of money. The world didn’t end. So, the feds – and their cheerleaders in the press – say they saved the world. ..But did they? No.

As to the actual state of the economy, the evidence is mixed and confusing. Yesterday, for example, stocks rose another 40 points on the Dow...but volume is low and another big drop could begin any day.

The NAHB announced that its index rose in February – but it was still the 6th worst reading for the housing index in the last 25 years. Meanwhile, mortgage applications are down. But housing starts are up.

Manufacturing is improving. Corporate profits are way up. But people don’t have jobs...and there is not much hope of finding them any time soon.

Besides, the world wasn’t coming to an end in 2008. All that was happening was that people who had made mistakes were getting what they had coming. Instead, the feds stepped in to save them...by ‘socializing’ their errors. Now, we’ll all pay for their errors. And pay much more. Not only are the private debts still there – more or less – now, we have trillions more in public debts to pay too. ....Way to go, feds...

Japan...and what happens to government debt:

All you have to know about Japan is that its population is aging and shrinking, Japanese companies have fewer Japanese customers this year than they had last year. And next year they will have fewer still.

That dooms the entire economy to a kind of permanent recession – which is what Japan has had for the last 20 years. The only sector that is not in recession is the export sector. They make a lot of good things which they export to America and to China. But if the growth stops in China...or the recovery doesn’t come about in the US...these exporters are doomed too.

Meanwhile, the Japanese government has been fighting the recession by borrowing huge amounts of money from the Japanese public and using the money for various public works projects. What you have to realize is that because the population is falling, the Japanese GDP – per person – has actually been positive for the last 10 years.

In other words, the average person is producing more, even though the economy, in gross terms, has been slipping. In effect, the government hasn’t been fighting a business downturn. It’s been fighting a population downturn. Of course, it’s a losing battle.

In Japan, it’s probably a hopeless situation. The government owes too much money to its own people. Sooner or later it won’t be able to finance its deficits. But then, it really won’t make sense politically to default. The debts are in yen and the government controls the yen.

It will probably use quantitative easing – otherwise known as the printing press – to pay its debts. And at some point, people will realize what is going on and become desperate to get out of all Japanese government obligations. Inflation is just another form of default. But it is politically more acceptable than a direct default.

“The outcome for America is less clear. A determined government with a mandate to put the brakes on could probably rescue the situation – a bit like Maggie Thatcher did in England in the ‘70s or like Paul Volcker did in America in the early ‘80s. At some point America too will have a hard time funding its deficits. It will be in Greece’s situation, forced to choose between making cuts in order to appease lenders or, just resorting like the Japanese to wholesale money printing.”

It should be added that America’s leaders are getting very bad advice. Their advisors have the wrong theory. They think the problem is a lack of demand...and they believe that they need to replace demand from the private sector with demand from the public sector.

They think Japan failed to stop its 20-year recession because it was too timid about spending money (despite all the evidence to the contrary) and that the Great Depression was caused when the Roosevelt Administration turned off the stimulus too early. They’re determined not to repeat that mistake.

Most likely, they will continue to borrow and spend until the economy recovers...or goes broke...whichever happens first.