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China Owns More Debt Than Thought: Did US Win Inflation War?

Interest-Rates / Global Debt Crisis Jul 06, 2011 - 04:38 PM GMT

By: Dr_Jeff_Lewis


It has been brought to the attention of the Treasury that China may own more US Treasury debt than once thought.  Rules put in place in 2009 limited would-be buyers of US Treasury debt to 35% of any given auction, but by using primary dealers (who have to buy US Treasuries at auction) as a proxy, the Chinese government has purchased more Treasuries than originally thought.

We have made clear before that the actions of Ben Bernanke are influenced by China.  With China keeping its currency artificially low by tethering it to a unique blend of global currencies, Ben Bernanke can “break” the bank of China with inflation.  If American investors expect a declining dollar, then it makes sense to borrow dollars for investment in China’s Renminbi, which pays a higher rate of interest.

Over time, this policy has forced China to cool off its economy.  Rates are rising, while the money multiplier is capped with rising reserve ratios.  A declining dollar combined with rising Chinese wages means that the manufacturing base that once went nowhere but China is now looking back to the United States, where various incentives and high unemployment mean ample opportunity in domestic manufacturing.

Why China is Buying Again

Purchasing US Treasury securities is a direct investment in the US dollar.  For institutions, governments, and even corporations, a US Treasury is like a paper dollar that pays interest.  Of course, for organizations of this magnitude, it makes little sense to invest in a bank account guaranteed only to $250,000.  The Treasuries are protected to infinity by the Treasury’s ability to print money.

China shows interest in diversification from US dollars.  It has an opportunity to save Europe with direct investment in Euro-denominated debt, and it also an opportunity to unwind its currency from the US dollar.

However, China’s recent investments in US dollars should be a sign that the Chinese are losing in this race to the bottom.  Not only is China’s economy slowing thanks to a removal of stimulus, but long-term decisions are now favoring the United States, not mainland China.  In buying US Treasuries, the Chinese connection to the dollar grows, even as China maintains that it is interested in moving away from US assets.

Will Bernanke Follow?

Realistically, if Bernanke followed the Chinese down to an inflationary policy, he should be able to follow the People’s Bank back up.  The US Federal Reserve could, theoretically, decide to increase interest rates or reserve ratios to cull back inflation fears.  An uptick in reserve ratios could even be combined with further quantitative easing without scaring investors to allow for more “stimulus.”

The ball, served by Bernanke, and returned by China, is now in the United States’ court.  Bernanke and Congress will have to decide to what end they’re interested in China owning US debt.  With China owning more debt than once thought—it could theoretically own all US debt through alternative vehicles—the US Federal Reserve will have to bring up the dollar’s value or face massive purchase of US assets by Chinese governments, companies, and foreign-held bank accounts.

Expect future volatility for the dollar in the coming weeks.  A debt ceiling vote combined with a cold war in inflation expectations between the US and China could make waves in the silver market. 

By Dr. Jeff Lewis

    Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of and

    Copyright © 2011 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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