Dumping the dollar?

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.

 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 dollars only.

You are viewing this from an individualist perspective -- the individual trader. Foreign governments have other concerns. When you're looking at a government such as China, its people trust the domestic currency in part because the foreign government holds so many U.S. dollars. The Bretton Woods system has conditioned foreign governments and foreign peoples to view the U.S. dollar as if it held intrinsic value, like gold.

Secondly, you act as if a complete crash in the dollar would not effect the global economy. That's absurd. Do you think the central banks and large institutions want the dollar to collapse and send the global economy into chaos? They want to preserve the status quo. They are supporting the dollar. Again, you're looking at it from a trader's perspective -- rationally, how to profit. Governments and central banks are not rational creatures. They have goals that do not pertain to profitability.

I do not dispute your thoughts on oil and the dollar. Actually, I was not aware of what you posted and I appreciate the education. Do you have a source online I can read more about this? When exactly did this happen? Around the time Volcker was put in charge of the Fed?

Your thesis is interesting and undoubtedly largely accurate. However, the U.S. government's ability to compel other nation's largely requires a viable dollar. Nukes are an option, but if the dollar is worthless, the government would have a difficult time paying for an army. Or do you believe the "patriotism" of soldiers would override their need to eat? There seems to be a paradoxical nature to your thesis. Correct me if I'm wrong. Sorry if I'm "silly." 

zeev:

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).

Can you provide more details or a reference or a citation? 

I am not doubting this assertion but rather, I would like to present the same argument to other people backed up with proof.   

 

Charles Anthony:

zeev:

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).

Can you provide more details or a reference or a citation? 

I am not doubting this assertion but rather, I would like to present the same argument to other people backed up with proof.   

 If it is the OPEC oil for dollars claim that you seek a source for, Ron Paul speaks of it, saying:

"Amazingly, a new system was devised which allowed the U.S. to operate the printing presses for the world reserve currency with no restraints placed on it-- not even a pretense of gold convertibility, none whatsoever!  Though the new policy was even more deeply flawed, it nevertheless opened the door for dollar hegemony to spread."

 

"Realizing the world was embarking on something new and mind boggling, elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC to price oil in U.S. dollars exclusively for all worldwide transactions.  This gave the dollar a special place among world currencies and in essence 'backed' the dollar with oil.  In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup.  This arrangement helped ignite the radical Islamic movement among those who resented our influence in the region.  The arrangement gave the dollar artificial strength, with tremendous financial benefits for the United States.  It allowed us to export our monetary inflation by buying oil and other goods at a great discount as dollar influence flourished."

 

"This post-Bretton Woods system was much more fragile than the system that existed between 1945 and 1971.  Though the dollar/oil arrangement was helpful, it was not nearly as stable as the pseudo gold standard under Bretton Woods.  It certainly was less stable than the gold standard of the late 19^th century."

 

"During the 1970s the dollar nearly collapsed, as oil prices surged and gold skyrocketed to $800 an ounce. By 1979 interest rates of 21% were required to rescue the system.  The pressure on the dollar in the 1970s, in spite of the benefits accrued to it, reflected reckless budget deficits and monetary inflation during the 1960s.  The markets were not fooled by LBJ’s claim that we could afford both 'guns and butter.'”

 

"Once again the dollar was rescued, and this ushered in the age of true dollar hegemony lasting from the early 1980s to the present.  With tremendous cooperation coming from the central banks and international commercial banks, the dollar was accepted as if it were gold."

 

Source:  http://www.house.gov/paul/congrec/congrec2006/cr021506.htm

 

 

 

Hi all! My name is Francis and I live in the Philippines. I don't know anything about US bonds or what, but I've gotten rid of all my US dollars (save the maintaining balance to keep my US dollar account open - $1.00) The Philippine peso is gaining rapidly in value, due to two things: the US inflating the dollar supply to keep the War going, and my President playing h