Taoyuan Nights

Funny things are afoot. In the last month, and particularly the last few days, the value of US debt started dropping very sharply. You can see this on the Swaprates site I mentioned yesterday - look at the US extended rates. There is a significant change in financial press sentiment too - the FT are running material about the ‘end of an era of low US rates’.

“The yield or interest rate on 10-year U.S. bonds closed at 5.126 per cent, up 0.16 of a percentage point on the day and half a point over a month.” - that is one heck of a move! (thestar.com)

What is happening? Here is one guess.

1. The US owes lots of money to Japan and China. They hold this debt mostly in the form of ‘long term fixed rate treasury bonds’ - in other words, a piece of paper saying the US government will pay out a regular stream of interest on what they owe.
   
2. However, the US appears to be experiencing higher than expected levels of inflation - mainly because there is stacks of new money being added into circulation by the banks. So it looks like the US will probably have to pay better interest rates in future to balance the ‘devaluing’ caused by inflation and an excess of dollars; and to try and limit the willingness of consumers to borrow cash.
   
3. This makes people think, ‘aha - maybe my fixed rate of interest on these treasury bonds isn’t so good then. Maybe I’ll just sell some.”
   
4. Therefore, the price of treasury bonds goes down, as the supply of them (the number of people selling them) goes up.
   
5. But, if you were China or Japan, and you had billions of these things, what would you want to do if you believed the price of them was going to go down? You’d want to get rid of the blasted things, sharpish, and swap them for something else that might keep its value better.
   
6. It *may* be that what we are seeing right now is the ‘US treasury debt’ system beginning to unwind. That is, China/Japan trying to get out of their positions. Further evidence for this can be found in the colossal investment into foreign equities that the PRC government is currently undertaking.
   
7. There’s something of a feedback loop - the more governments sell US treasuries, the more other countries will want to get out of them too!
   
8. This is all well known, of course. The interesting thing is that it hasn’t happened yet. Like a group of poker players trying to bluff each other, everyone has kept playing the game. But perhaps we are now reaching the end of the game.