Pulling the plug on U.S. debt
By William Pesek Jr. Bloomberg News Monday, November 29, 2004
In real estate, it's location, location, location. With markets, it's timing, timing, timing. Asian central banks should consider this most basic of credos and sell some of their massive holdings in U.S. Treasuries.
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The reason: Now may be as good a time as any for this region's monetary authorities to avoid losses ahead of a possible surge in U.S. debt yields.
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The U.S. economy is experiencing a mix of employment growth, solid retail sales, a sliding currency and record oil prices at a time of accelerating inflation. That is the kind of combination that disconcerts bond investors, and it seems only a matter of time before U.S. yields skyrocket.
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Asia's central banks would suffer big losses if that happened. The combined U.S. Treasury holdings of China, Hong Kong, Japan, Singapore, South Korea, Taiwan and Thailand come to $1.1 trillion. Every increase in U.S. yields, no matter how mild, is costing money that comes out of the coffers of Asia's central banks. Why not reduce that risk now?
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Leaders here have a perfect opportunity to plot an escape from U.S. bonds during the next few days as they gather in Vientiane, Laos. Leaders of China, Japan and South Korea, all major U.S. Treasuries buyers, also will attend this year's summit meeting of the Association of Southeast Asian Nations.
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Of course, it would be even better to see central banks go further. Asia's fixation with weak currencies to stimulate growth has led to an unhealthy addiction to dollar-denominated debt. Asia should put that money to productive use here instead of helping to finance record U.S. deficits.
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At the same time, a rising currency attracts more foreign capital, bolsters stocks and lowers bond yields. Letting exchange rates rise also puts pressure on governments to implement reforms to increase domestic growth.
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Yet Asians worry that the United States will go too far in weakening its dollar and that it will do so at their expense. Of course, they may have a difficult time accusing the United States of doing precisely what they've been doing for years: using a weak currency as a crutch. Such an effort by Asians would fall especially flat in Europe, which is bearing the brunt of Asia's policies in the form of record highs for the euro.
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In a perfect world, Asians would let the dollar plunge. Not only might that stimulate the world's richest economy, but it might also pressure the U.S. to get its record budget and current-account deficits under control. If so, the global financial system would be better off.
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Still, Asians cannot help but think that Washington wants to have it both ways. Dumping U.S. debt might serve as a wake-up call for the Bush administration, which seems to think it can devalue the world's reserve currency to bolster U.S. employment without suffering the side effect of rising debt yields.
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Steady Asian purchases of Treasuries are helping the United States avoid much of the corresponding rise in yields that comes when a currency falls. If Asian central banks dumped their Treasury holdings, the United States would be forced to seek a balance between a softer dollar and rising interest rates.
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To Andy Xie, chief Asia economist at Morgan Stanley, allowing the dollar to slide is "simply another way to get foreigners to subsidize U.S. spending" so that Americans can continue living far beyond their means.
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"Asia can fight back," Xie says. "The U.S. uses its superpower status and the advantage of the dollar as the currency for trade pricing and central bank reserves to get foreigners to fund its outsized spending habit. Without a market signal, this U.S. shopping addiction won't stop."
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Xie thinks that even if Asian central banks sell Treasuries now and keep the dollars only in cash form, U.S. bond yields could rise 1.5 percentage points. The 30-year bond currently yields 4.83 percent.
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"That higher bond yield would stop the merry-go-round among the Federal Reserve, the hedge funds, the Asian central banks and the U.S. consumer," Xie says. "With higher bond yields bringing down U.S. consumption, the global imbalance would heal."
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Treasury Secretary John Snow recently pledged that the United States would get its imbalances under control. Yet it's hard to keep a straight face when President George W. Bush seems determined to cut taxes further. Given this administration's track record, that can only mean bigger U.S. deficits.
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Doing that would be harder if Asians pulled the plug on U.S. Treasuries. The corresponding jump in debt-servicing costs might force the United States to consider raising taxes to trim its fiscal deficit. That might stabilize the dollar and Treasury yields over time as markets bet on for fewer U.S. securities.
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"So why take the roundabout way, since the solution is higher U.S. interest rates in the end anyway?" Xie asks. "If Asian central banks sold Treasuries now, it would bring the issue to a head."
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