The Ron Paul campaign has lots of people talking about the perils of a debased US dollar. One concern bandied about is that foreign holders of US bonds like China, Japan, Saudi Arabia, etc, will eventually dump their copious supplies of US bonds in favor of a higher return in a different currency, upon which all hell breaks lose and the US economy crashes. My question is, if these nations did not dump the dollar when it first lost 25% of its purchasing power, or 50% or 75%, why are they going to start when the dollar loses even more value, i.e., >95%? If bond holders are so concerned with the dollar then why didn't they bail out long ago? What is going on here and should we really be concerned with a falling dollar vis a vis foreign bond holders? Thanks.
Dumping the dollar would be very difficult for these foreign governments. After all, it's not as if they can convert their dollars for euros at a fixed price. As they were dumping, they would drive the price down. The price they got for the first dollar sold would be much higher than the price they got for the last dollar sold. The perception of the dollar as being worth anything is beneficial to many of these regimes, whose people only accept their own fiat currencies because they know their governments have stockpiles of "real" U.S. dollars.
They won't dump the dollar until it is essentially worthless. In other words, foreign dollar-dumping will not be the cause of the dollar's decline, but one effect. At least that is how I see it.
Jason,
Thanks for responding. I see your points and it makes sense that other governments want another currency to back their own fiat currency. The other possibility is that they never intended to redeem the US bonds in the first place. In other words, it's just a "grant" from, say, the people of China to the US Treasury. It's all very twisted, isn't it?
So my next question is, why would governments continue to invest in US dollars given its present weakness? Wouldn't they prefer something stronger like the euro or the pound? Some think that governments are compelled to buy US bonds through threat of force or sanction. Who knows?
Mike
Mike - U.S. bonds aren't redeemed at the option of the holder. They are of varying maturities (bills, notes, and bonds), most of which pay interest every six months and then are redeemed, automatically, at maturity. So these bonds are not grants. The foreign governments who hold them are receiving interest payments and principal, and using that income to buy more bonds. However, I don't think the foreign holders of these bonds account for a very high percentage of the debt. Individuals, both foreign and American, as well as the Federal Reserve itself, buy more bonds than foreign governments (I'm pretty sure, at least).
Post WWII, the U.S. dollar became the world reserve currency. Other governments used the dollar as if it were gold, and only the dollar itself was redeemable for gold (and only in transactions between the U.S. and foreign governments or major financial institutions). In 1971, the convertability was severed, but foreign governments have continued to use the U.S. dollar as if it were still backed by gold -- as if it were gold itself. Old habits die hard.
There are probably some here who would disagree, but from my understanding, a strong dollar is actually good for these foreign governments. After all, a weak dollar lessens the value of their holdings, and is also unfavorable for them in international trade. I think the foreign governments, thus, want a strong dollar. They are propping it up by their continued purchase of our debt.
U.S. bonds aren't redeemed at the option of the holder.
Jason, thanks again for correcting my misunderstanding. But can't the bond holder sell bonds on the market before maturity? If not, then it would be hard for there to ever be a sell-off crisis per se, right?
They are propping it up by their continued purchase of our debt.
Yeah, I still don't get it. Why would they buy a bond held in a weak dollar? Why not buy into a stronger currency?
thanks, Mike
Yes, they (or anyone else) can sell the bonds prior to maturity, and yes, this would push the prices of the bonds down and the yields up. They could gradually do this, but as they did, the value of the bonds would go down, so that, eventually, (if they were to sell them off entirely), the price they got for the last bonds they sold would be much lower than the price they got for the first bonds. They would be selling these bonds for dollars, getting fewer of them, and then turning around and (presumably) trying to convert the dollars they had -- with a diminished value -- for another currency or currencies. This doesn't seem like a very logical thing to do. Their purchasing power at the end of such a selloff would be much lower (from my understanding, at least) than the theoretical purchasing power they had prior to the selloff. It seems it is a better strategy for the foreign banks, etc., to apply a slow bleed to the dollar. Keep collecting the interest and redeeming the bonds as they become payable, but don't destabilize the currency. Why destabilize the currency when they hold most of their reserves in that currency?
As for your second question: My understanding is that they buy into the weak dollar to prevent it from getting weaker still. They hold their reserves in that currency, so its collapse would be an economic calamity for them just as much (or nearly so) as it would for us.
My prediction, as stated earlier, is that a foreign selloff in Treasury bonds and dollars will not be the cause of the dollar's ultimate demise, but an effect. The dollar will become thoroughly devalued through other means first. I am no expert, but that is how I see it playing out.
My understanding is that they buy into the weak dollar to prevent it from getting weaker still.
Hmm. The game theorist in me says that that strategy won't work. If bond holder A knows that B is going to hold out for fear of driving down the value of the bonds, then A could sell off first knowing that B is going to hold in order to prop up the dollar. Thus, if the dollar is weakening the stable strategy should be to sell early and often in order to beat the other guy to the market. So perhaps I should qualify my previous question and ask, why not sell when the dollar is falling? Seems to me like any bond holder in such an environment should damn the future for the sake of immediate profit. So I guess I'm still not conviced that we know why bonds are held in weak currency (unless there's some form of coercion).
M
Let's say Bondholder A is China and Bondholder B is Saudi Arabia. If either decide to dump their bonds on the market, the most likely buyer is Bondholder C -- the Federal Reserve. They will step in and buy the bonds, thus keeping interest rates at or near their target, but in the process, depreciate the dollar by creating more money. When China or the Saudis sell their bonds, they do so for U.S. dollars. Now they have even more dollars. If they want to get out of the dollar, selling bonds is not the way to do it. And the dollars they get for the bonds they sell are worth less, all of their dollars are worth less, than before they made the sale.
I did a little research. Only 22% of U.S. debt is held by foreigners. 36% is held by American individuals and institutions. And 42% is held by the damn Fed.
My understanding: A dollar dumping strategy by any large holder, particularly a government or central bank, would be suicidal. Others may have a different perspective, but that's how I see it.
Dumping is a remote worry. If they simply stop buying, the dollar is in trouble.
Minarchism failed because it is socialism || A challenge to minarchists || Private roads and cities || A two-stage strategy for freedom
So if other governments stop buying U.S. bonds then would the Fed step in and buy them up using, of course, counterfeited money? Could the Fed buy up all the bonds?
Sure they could. They can do virtually anything they want.
Of course, creating the money to buy all of the bonds would be massively inflationary.
But here's another thing I think you might not be getting: The interest rates of the government bonds are set by the market. The Treasury says, "We have this $1,000 bond that pays $25 every six months, and then is redeemable for $1,000 in ten years. How much will you pay for it?" Bidding then ensues. If they bid the bond up to $1,100, then the interest rate of the bond is 4.54%. If they bid it down to $800, then the interest rate is 6.25%.
Point being: Governments and other investors won't just "stop" buying government bonds overnight. They will demand higher and higher interest rates. They might bid only $500 for a $1,000 bond paying $50 a year. The Fed already steps in, artificially, to bid up the prices of the bonds. The "real" bond rate is much higher than the Fed allows it to be.
I see. Thanks for the explanation.
Jason's argument is silly because if you're holding a depreciating asset and you know the asset will continue to depreciate, you'd want to get out at any price because it will continue to go down potentially to zero. As a trader, I know this. Nobody thinks of holding onto something just because the price you get for your last lot will be lower than for your first. The real reason dollar reserves are being held all over the world despite dollar's continuing depreciation is because of oil. A bit of history is needed to comprehend this. In 1980, when gold hit $870/oz, silver went above $50/oz, oil was at record highs, interest rates were north of 20%, and dollar was in hyper-inflationary free fall, the feds did something unprecedented. They coerced oil-producing nations to accept only dollars for oil, at all costs (including a potential nuclear war). Everyone agreed (no choice). So that basically linked the dollar to a commodity, but instead of gold it's oil. And for 20 years the dollar's inflationary devaluation was manageable. Comes the bursting of the dot-com bubble in 2000, as well as 9/11 and Greenspan went all out. The dollar's course became outrightly and clearly one-directional - DOWN. This is why EVERYTHING is going up with the exception of the dollar (the yen is in a down trend too, but that's a special case).
This is why the US is maintaining military presence in over 120 countries around the world - to support the dollar. There are very serious private special interests involved here. This isn't a walk in the park type of situation. Unsympathizing high ranking officials get deposed, and the president is not excluded; elections get rigged, etc. Countries get invaded and regimes changed... guess why Hussein had to be hanged? He stopped taking dollars for oil. Guess why Iran is next? Iran has stopped taking dollars for oil.
The dollar will be dumped when, and only when, the world will no longer have to buy oil for