According to the US Treasury, the two largest buyers of US Treasuries have been Japan and China. Japan is now the largest holder, but this reflects the interests of mainly pension funds, insurance companies, and a carry trade. Most of the $775 billion recorded as Chinese is the Chinese government itself, making it by far and away the single largest holder. This is because China exercises exchange controls, thereby limiting foreign investment by domestic institutions. And in the past the Peoples Bank has accumulated dollars and US Treasuries (and gold) as a consequence of trade surpluses.
Britain and others are also listed as major holders. But as in Japan’s case, these are not holdings of government agencies and cannot be influenced by the US Treasury directly. This is why the US Treasury is liaising with the Peoples Bank and China’s treasury officials, trying to persuade them not to sell but to buy more US Treasuries. Being in a debt trap, the Americans will be desperate to secure funding without interest costs rising making a deteriorating government debt position even worse.
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So far this fiscal year, the Treasury has been funding its deficit through Treasury bills, short-term discounted instruments for which it currently pays the equivalent of over 5%. But there comes a point where excess liquidity in money funds and bank balance sheets runs out, and the Treasury must contemplate term funding along the yield curve. Banks will be reluctant to take on duration risk, and anyway will want to reduce their balance sheet leverage in a struggling economy. As the largest single holder of US Treasuries this is why China matters.
China’s authorities now have an important decision to make. Do they bail out the Americans, or do they cut their losses on $775 billion?
If China refuses to buy more US Treasuries, and we must be talking about significant quantities, bond yields will rise threatening to destabilise both the US financial system and the global (western) economy. In theory, there may be a deal to be done. In exchange for bailing out the US Treasury, the administration could guarantee continued access to US markets, taking tariff increases and sanctions off the table. But Yellen has already criticised China for subsiding production, in her words threatening US jobs. Furthermore, Trump is likely to be the next US President: with his anti-trade policies all bets are off with respect to trade guarantees. And the Americans have proved to be consistently unreliable parties to agreements.
The funding quantity required is probably far larger than the Chinese government could consider underwriting even as a marginal buyer. Furthermore, it would go against her policy agreed with Russia, Saudi Arabia, Iran, and others to do away with the dollar over time. Instead of rescuing the Americans from their debt trap and not jeopardising her exports, China appears to have little alternative to letting events evolve without their intervention.
It is this realisation which has probably led to the Peoples Bank selling dollars for gold. Other Asian nations will have seen this coming, from Japan to Hong Kong and even Taiwan. Without a key foreign buyer, a funding crisis is likely to rapidly spread, putting off other foreign buyers and even domestic US institutions. The Bank for International Settlements has also warned us about the problem.
No foreign investor in his right mind should buy US treasuries. Bond yields could begin to rise with surprising rapidity: no wonder the chart below rings alarm bells.
The chart confirms that having completed a bullish golden cross in mid-February, bond yields are headed higher, consistent with a developing debt funding crisis. Including funding costs, the current fiscal year’s budget deficit will probably exceed $3 trillion. By way of confirmation, Treasury debt recently took only 90 days to increase by a trillion, an annualised rate of $4 trillion, confirming that the deficit is turning out to be considerably worse than government forecasts.
China sees it, and in an election year knows that it will be virtually impossible for the Americans to adopt any discipline on the budget deficit. We can only conclude that China is exceedingly unlikely to bail out the US Government. Other than protecting her exports to the US, it is becoming indefensible to throw good money after bad. With her SCO and BRICS allies, she must prepare for a dollar crisis, which will undermine the purchasing power of the other major currencies in the western alliance. It will mark the largest geopolitical event since the collapse of the Soviet Union and the death of Mao.
China has been preparing for this event for decades. In Marxist universities they taught that capitalism would eventually destroy itself, and that the capitalist currencies would lose credibility. The current generation of US-educated Chinese movers and thinkers may have forgotten this, but the old guard has not which is why China still hoards gold. All indications are that China has had a policy of accumulating gold since 1983, when the Peoples Bank was appointed to manage the accumulation of gold and silver bullion. Do not be surprised if this forty-year policy of accumulation leaves the Chinese government with over 30,000 tonnes in addition to the PBOC’s official reserves.
Belatedly, Russia has begun to rebuild her gold reserves, and is known to have gold in two state wealth funds. The quantity is unknown, but usually reliable sources suggest that together with her central bank Russia can command about 12,000 tonnes. If so, then she has gold reserves well in excess of those of the US whose quantity is widely believed to be overstated.
Predominantly an exporter of energy, Russia has concentrated on forging relations with oil producers, notably Iran and the Saudis. Russia is the ringmaster for Asian energy security, allowing Asia to be independent from US economic and political policies. And increasing hostility from America and her NATO allies has persuaded Putin that the Americans must be driven from Eurasia, including Eastern Europe, as well as the Middle East.
Put bluntly, removing a belligerent America and her currency from Asia is the joint objective of Russia and China, while a desperate America is determined to cling on to her Asian footholds with the assistance of her compliant allies.
The war in Ukraine is gradually being won by Russia, and with the ground drying out the fighting season is resuming. In anticipation of this escalation, the Biden administration has passed a bill providing an extra $60.84 billion in military aid for Ukraine: it is desperate for Ukraine not to be defeated before the presidential election in November. But given that Ukraine’s dwindling ammunition stocks will be replenished in a few weeks, we can now expect Russia to increase her efforts to bring the war to a close.
In the Middle East, America is trying hard not to be drawn into attacking Iran directly. But there is little doubt that it is getting increasingly involved behind the scenes, as indeed are Russia and China. That the US, UK, and Jordan led the shooting-down of Iranian drones and missiles is public knowledge. But that Iran is using China’s Beidou satellite navigation system in conjunction with Russia’s GLONASS satellites for precision weapons guidance has escaped media attention. As journalist Pepe Escobar points out, this is BRICS+ cooperation with Asia coming together against American hegemony.
The message for America is to butt out of West Asian affairs, just as it is to get out of Ukraine. And at the eastern end of the continent, China has conflicts with America over Taiwan and the wider eastern Pacific. The two Asian hegemons must feel that they have the Americans on the run. But the enemy is still dangerous.
Outright military confrontation is obviously unpredictable and risky, with the western belligerents already moving onto war footings. As Viktor Orban of Hungary put it on Tuesday, “Today in Brussels the majority are parties of war. A military mood reigns in Europe and politics are governed by the logic of war. Everyone from all sides is preparing for war”.
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Putin might take the view that with a weak US President in his election year, it is a good time to challenge American resolve. The stage is set for an escalation of hostilities over Ukraine which could get rapidly out of control.
For China, it is increasingly obvious that the glory days of building her economy on the back of exports to western trade partners are over. Not only is she facing increasing hostility led by US propaganda, but to continue to protect this trade will be at the expense of her influence over global affairs. Instead, she must concentrate on the development of trans-Asian economic potential with her African and Latin American supply chains.
Achieving her macro-objectives increasingly requires American belligerence to be neutralised, and the best way to do this without being noticed is to simply allow the US to drift into bankruptcy by denying her additional debt funding. It may also be in her interests to ensure that her rejection of dollar credit extension is noted by her allies, so that foreign funding is effectively closed off to the US Treasury.
Inevitably, the dollar’s value and those of aligned fiat currencies will become rapidly undermined as the dollar debt trap slams shut. China and Russia will have to protect their currencies by introducing credible gold standards. Other nations in their spheres of influence will have to make similar arrangements, either linking their currencies to golden roubles or renminbi, or to their own gold reserves.
We appear to be rapidly approaching an inflection point, whereby the only way to avoid WW3 is for China and Russia to emasculate America and her allies financially.
Reprinted with permission from MacleodFinance Substack.
