Is it me or would "china dumping us bonds" have absolutely no effect since the Federal reserve is already the only one buying us bonds in massive quantities ?
China's holdings are significant - over $1.3tn or around 7.5% of all US government debt. If they were to dump all of it onto the market at once (a crazy idea which they would never do), the simple excess of supply over demand would cause Treasury prices to plunge and the USD would likely drop in the foreign exchange markets too.
As soon as someone at one of the big US investment banks realised what was going on, phone calls would start being made to wake people up in London and then New York (this assumes that the sell-off starts during Asian trading hours) and eventually someone would wake up Bill Dudley (head of the New York Fed). He, in turn, would wake up Bernanke and Lew, who would call the President (who'd probably already have been woken up by the IC/military).
By that point, the markets would be in turmoil. The combination of the sell-off with a big military move (i.e. declaring the South China Sea a closed zone) is interesting, because an increased likelihood of military conflict typically causes investors to sell riskier assets and buy less risky ones, like US Treasury bonds. So, stock markets would drop across the world - I'd say at least 3%, probably more like 5%. Buying gold and oil is like a bit of a kneejerk reaction in times of geopolitical turmoil, so those would probably rise.
I doubt the increased demand from investors for Treasuries would be enough to absorb $1.3tn worth of bonds so Treasury prices would be dropping through the floor. That introduces a new dynamic because Treasuries are commonly used as trading collateral, so you'd start seeing margin calls, just like we did during the credit crunch (which is what caused Lehman Brothers to collapse).
So, Dudley would almost certainly act to stabilise the market by instructing the Fed's trading desk to start buying Treasuries. I don't know what the practicalities are of the Fed buying $1.3tn at short notice (e.g. whether they can simply create that many dollars out of thin air and credit them to their counterparties' accounts) but, assuming they could, that would support the price of US Treasuries although yields would probably still end up jumping by at least 100 basis points, and the USD would probably drop significantly against the Euro.
So, all in all, I'd be inclined to disagree with the idea that China dumping US bonds would have absolutely no effect. :-)
Ah. Yes. They can totally do that.
So the question is whether their extant open-market operations which aim for a particular interest rate on Treasuries will in fact buy the bonds quickly enough that substantial market turmoil would be avoided. And, if so, whether the increased supply of USD would have a higher velocity than it did when China was sitting on it, which could lead to a weaker dollar or substantial inflation.
(And of course, people could just generally freak out anyway, leading to turmoil.)
Yeah, I had been thinking about how TARP required congressional approval but, of course, the _reason_ it required congressional approval was because the "troubled assets" in question were not Treasuries. A little investigation reveals that section 14 of the Federal Reserve Act authorises the Fed "To buy and sell, at home or abroad, bonds and notes of the United States".
> ..whether the increased supply of USD would have a higher velocity than it did when China was sitting on it, which could lead to a weaker dollar or substantial inflation.
Weaker dollar? Definitely. I expect the ECB and banks of England and Japan would buy dollars - both to help the US stabilise markets and to avoid their own currencies growing tooo strong - but I'd still expect to see a significant drop in the value of USD. 20%, maybe?
Substantial inflation? Inflation is a longer-term, delayed reaction sort of thing so I reckon it would depend on what happened subsequently.
The funny thing is that, having been through the turmoil of September 2008, the financial system is probably better prepared and positioned now, than it was before the Financial Crisis, to deal with the turmoil that would be caused by China dumping its Treasury holdings.
The question is what the side effects of that would be. So perhaps I should say they can prop up the nominal price for as long as it wanted. The real price can't be manipulated so easily.
So no, it wouldn't be business as usual...if this were a real story.
Good analogy though, because separating conjoined twins in a manner analogous to dumping all its bonds would kill both. The US economy would be in ruins, and the US would reply the only way it knows how, war. I suppose war is as much an economic tool as anything else. But there is another reason why China could never dump its bonds, it would destroy its biggest market, the US.
Capitalism, the biggest force for peace we have....... (If reading that last bit made you feel nauseous, imagine how I felt typing it. Im trying to kid myself it's ironic, but its not working.)
The USD being world reserve currency has been printed far beyond the needs for internal domestic trade. The US had to do this to lubricate world trade, however when the music stops all those dollars held in foreign banks will try and make their way home in order to obtain some value. A flood of dollars will then start bidding for goods and services from the US economy. Instant hyperinflation.
The US haven't defaulted on their debt because the roll over their debt with more USD.
I just checked the numbers, and in 2011 the second quantitative easing (aka "printing money") was 600 billions, and the third is 40 billions every month. And it doesn't have any impact on inflation (which remains a bit of a mystery to me, unless this money is instantly used by the banks just to balance banks internal debts and taken out of the economy).
But it wouldn't in and of itself cause catastrophic hyperinflation. Not on an ongoing basis, anyway. Continuing inflation requires continuing increases in the monetary base (or monetary velocity).
The whole thing is kind of moot since China would be committing economic suicide by doing this.
Meanwhile will the rest of the world be willing to ship real goods and services in return for promises of ever more paper IOUs from the USG, and when those paper IOUs are due, the promise of even more paper IOUs?
If this all sounds sustainable, I have a deal for you. I want to borrow $100 off you and I'll pay you $105 next year. Don't worry, I'm good for it. I'm also lending myself $200 and will pay myself back $210 next year. So how about it? Clearly the 5% interest rate is what has been set by the market (me) so you are getting a good deal.
Next year comes around and I hand you some paper IOUs for $110 the next year. Meanwhile, I'll borrow another $100 off you. I've been living it large and need a bit more sugar. Don't worry, I'm good for it - I'll lend myself another $200 too!
The member banks of the federal reserve are required to buy government debt if nobody else will.
Apparently you haven't taken enough college/graduate studies to unlearn common sense. Unfortunately, that disqualifies you from being an elite.
To get those kind of jobs, you need to be for example a phd 'expert' on the great depression such that you come as close as possible to repeating it (biggest national housing and credit bubbles ever).