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Warning Bell? China May Stop Buying US Debt

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Ding.

They say bells never ring when markets hit the top. But maybe they do and people just don’t listen.

Yesterday, Bloomberg reported China may slow or even stop its purchase of US Treasuries. In other words, a major source of US government debt financing may be pulling out. This comes at the same time the Federal Reserve has committed to shrinking its balance sheet. 

“The Chinese are applying pressure to the Treasury market just as the (Federal Reserve) is about to step away from being the buyer of last resort,” FX strategy at BK Asset Management managing director Boris Schlossberg told Bloomberg.

So could this be a ringing bell?

In his latest podcast, Peter Schiff called it “an ominous sign.”

A. China is the largest buyer and owner of US Treasuries in the world. But B. we just cut taxes. We cut taxes and not spending, so we are financing these tax cuts by borrowing more money, by running bigger deficits, by selling more bonds. And if the largest buyer and owner of those bonds is saying, ‘No más,’ well then that is a big problem. Because who is going to step up and replace the Chinese?”

Peter made went on to make an interesting point – who would even want to buy US Treasuries at this point? Even if you aren’t an economic doom-and-gloomer, the current bond market and historic bond prices don’t make them particularly desirable assets.

Aren’t there other assets you would rather own than extremely low-yielding US Treasury bonds? So, if the Chinese don’t want to buy, it stands to reason a lot of other people don’t want to buy either. Especially if they know the Chinese are not buying.”

This raises another question. If the Chinese stop buying US Treasuries, will they start selling what they have? The fact that they don’t want to buy would seem to indicate they are bearish on US debt. It wouldn’t be unreasonable to think the next step might be to sell. Or China could follow the Fed’s strategy and simply let their bonds mature, decline to roll them over, and ask for their money back.

Where is the US Treasury going to get China’s money back if China’s not going to loan it to them again? If the Federal Reserve isn’t loaning it again? Where are they going to get the money? They can’t. That is the problem. You know, it’s amazing how few people are worried about a problem so potentially ominous as this one.”

What was the 2008 financial crisis all about?

Too much debt.

People took out too much debt and put it into real estate. When the market crashed, the house of cards came tumbling down.

What do we have today?

Too much debt.

Interest rates were key to the 2008 crisis and they will play a key role again. In the years leading up to the financial crisis, a lot of people bought houses they couldn’t afford. But because they got low-interest teaser rates that kept payments low, they bought in, thinking the increase in the value of the home would allow them to refinance or sell when the teaser rate expired and the payment went up. When the bubble burst, people were left holding the bag. Fast forward to today.

The United State Treasury has a teaser rate on a $21 trillion national debt, and what the Chinese are saying with this bell that they’re ringing is this teaser rate may be expiring soon and interest rates may be going back to normal.”

In fact, rates could go beyond normal. After all, pendulums swing both ways. Since we’ve had historically low rates for years, it could go the other way to historically high rates.

All of this has huge ramifications for the American economy. Even normalized interest rates would crush the US budget under interest payments. Analysts have calculated that if the interest rate on Treasury debt stood at 6.2% – their level in 2000 – the annual interest payment on the current debt would nearly triple to $1.3 trillion annually.

The people who are ignoring this problem – they have to assume that interest rates will never normalize – that these ridiculously low interest rates that we have are going to stay here forever. Now, that seems to be a crazy assumption. What’s more crazy? To assume that interest rates will eventually go back to normal? Or to assume that they’re never going to go back to normal?”

You have to believe rates will never go back up to believe we are not heading for a major economic crisis. The fact is, the federal government cannot afford to pay the interest on its debt in a high-rate environment. Something has to give.

Is that the sound of bells I hear?

Get Peter Schiff’s latest gold market analysis – click here for a free subscription to his exclusive monthly Gold Videocast.
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