Dumping Treasury Bonds?

A couple of different readers have pointed me towards articles about China dumping Treasury bonds, such as this one from the September 6, 2007 Daily Telegraph:

A sharp drop in foreign holdings of US Treasury bonds over the last five weeks has raised concerns that China is quietly withdrawing its funds from the United States, leaving the dollar increasingly vulnerable.

Data released by the New York Federal Reserve shows that foreign central banks have cut their stash of US Treasuries by $48bn since late July, with falls of $32bn in the last two weeks alone.

"This comes as a big surprise and it is definitely worrying," said Hans Redeker, currency chief at BNP Paribas.

"We won't know if China is behind this until the Treasury releases its TIC data in November, but what it does show is that world central banks are in a hurry to get out of the US. They don't seem to be switching into other currencies, so it is possible they are moving into gold instead. Gold is now gaining momentum across all currencies and has broken through resistance at 500 euros," he said.

While the greenback has been resilient over recent weeks - even regaining something of a 'safe-haven' role as banks scrambled to buy the currency to cover dollar debts - most experts believe that America's $850bn current account deficit will eventually cause the dollar to resume its relentless slide.

The article points out that China has denied doing so:

Two top advisers to the Chinese government gave strong hints in August that Beijing should use its estimated $900bn holdings of US Treasuries and agency bonds as a "bargaining chip", words taken as an implicit threat to trigger as US bond crash if provoked.

The Chinese government has since put out an official statement clarifying that it has no intention in taking such an irresponsible step, which would in any case backfire by devaluing China's remaining holding.

Mr Powell said the switch out of Treasuires was a purely commercial decision. "If if turns out that the Chinese are behind this, it is merely an attempt to increase returns on investment. It has nothing to do with settling protectionist scores," he said.

What if China sells off Treasuries and agency bonds? This drives down the price of the bonds--which is a bad thing if you are currently holding those instruments, and can't afford to hold them to maturity--or until the market recovers. As prices fall, however, the yield rises inversely. If you need a high yielding investment, you might then be able to buy those higher yielding bonds on the cheap, and get a low-risk investment that pays very nicely.

I think there is a downside, however. Rising yields will make it more difficult for those agencies (many of which finance housing in the U.S.) to continue offering low interest rates on mortgages. Since mortgage rates are already higher than is good for housing prices, this might force the Fed to cut interest rates to revive the economy more rapidly than is good for inflation.

On the other hand, a falling dollar is good for U.S. manufacturers and exporters (like ScopeRoller), because it makes U.S. goods cheaper to export, and easier to sell than goods imported from abroad.