Real Downgrade Is When China Dumps Their Treasury Holdings

Posted by Jeff Rubin on August 10th, 2011 under SmallerWorld • 16 Comments

It is not that difficult to discover who is the most concerned about Standard & Poor’s recent downgrade of the United States’ coveted AAA credit rating.

The People’s Bank of China owns more Treasury bonds than anyone. All of a sudden, the liquidity of the U.S. Treasuries market no longer looks so appealing for the $1.5 trillion treasury bonds or so of china foreign reserves that have found a home there.

China, like most of the U.S.’s foreign creditors, wants serious action on cutting Washington’s monstrous budget deficit. But the political gridlock between the Republican dominated Congress and the Democratic administration, which has stood in the way of serious deficit reduction, may become a permanent feature of the U.S. political system. Who’s to say Americans don’t elect another hung jury to Washington after next year’s presidential election?

More important, even if Americans can come to a rare political consensus and agree to cut government spending and raise tax rates would the tough fiscal medicine demanded by the credit rating agencies actually do what it is intended to do? Can fiscal restraint reduce deficits in barely growing economies?

Runaway federal spending and unfunded tax cuts are only part of the legacy of Washington’s deficit. Faltering economic growth is not an innocent bystander here. During the first half of the year, the U.S. economy hardly grew despite the benefit of both fiscal stimulus and quantitative easing. How is the U.S. economy likely to perform when neither are no longer around?

Even more challenging, what happens if Washington actually took deficit reduction seriously and started to chop spending and raise taxes like the distressed PIGs in Europe are being forced to do? As the Greeks can tell you, these policies do not exactly boost GDP growth. In fact, it seems the more the PIGs cut, the more their deficit grows as their economies and their tax bases continue to shrink.

without the continued support of the People’s Bank of China, the U.S. can’t finance its fiscal deficit any more than Greece, Portugal or now even Italy and Spain can finance theirs. And as I have argued before in this blog, the days of Cbina slavishly financing Washington’s huge budget deficits are drawing to a close.

The loss of America’s AAA credit rating brings us that much closer to the day when the People’s Bank of China doesn’t show up at the Treasury auction. Their absence in the future, more than any proclamation by any credit rating agency will be the real downgrade that awaits the U.S. Treasury market.


  • JB

    If China does not show up US Treasury auctions, it might find it rapidly difficult to maintain its current profit margin on manufactured products sold in the US.

    Donald Trump is now calling for a 25% import tax on all imports from China to balance the US budget…


  • Rojelio

    I’m reading right now that people are flocking towards US treasuries while the stock market is flailing. Perhaps because there are no good alternatives other than gold? How long can this last?

  • eugene12

    That’s a real smart solution. American cost of living skyrockets and, as typical for American solutions, the poor are hit the worst. We don’t make anything anymore and are totally dependent on imports of all kinds for our daily living.   While it’s pleasant to blame industry, government policies or whatever, a significant culprit in all this is the American worker who wasn’t, and isn’t, competitive in the global market. 

    Everywhere I hear “it’s not our fault we’re in this bind”.  In other words, we’re these poor innocent people that everyone is picking on.  China is simply the scapegoat for decades of irresponsible American actions starting with each and every one of us.  We are in a catastrophe of our own making.  I, and many others, have been watching it develop for a long, long time. 

    If Obama doesn’t take the next election, I fully expect us to elect some nut case that is a fanatic on one scapegoat or another.  I’m no fan of Obama either so don’t want to read the normal crazy partisan return comment.  But if you’re so inclined, type away.

  • k.cobley

    The inability of resources to provide for continued economic growth is the problem. How to manage decline is the approach that is needed. The playout by the freakshow in Washington shows its only a matter of time before London moves to US streets.

  • Dhouston

    And the US has to take some hard action to repair the massive trade deficit it has with China. It’s no longer free trade it’s unfair trade. There won’t be jobs created in the US again unless they bring some manufacturing jobs they have lost mostly to China.

  • Dhouston

    This supports my view that oil prices even at 80 dollars will impede any serious economic recovery

  • Dhouston

    “American worker who wasn’t, and isn’t, competitive in the global market.  ” Tough to compete against slave labour wages and countries like China that has lax environmental standards. Some kind of tariff increase is in order no as high as 25% but they have to send a message to even out the balance of trade. Cost of imports may rise on some things but some manufacturing jobs should return stateside. Without a manufacturing base recovery is unlikely

  • Instincts

    Ya, and just look at how prices at the pump have not translated into the same loss as crude oil, further adding to such impedence.

  • Instincts

    In reply to both of you, it all comes down to standard of living.  North
    Americans have arrived at a certain standard of living, whereas other
    nations like China have had theirs.  Having relatively recently
    colonized this continent, with wide open opportunities over the last 2.5
    centuries, we chose as a society to arrive at this standard of living. 
    That standard of living, on average, can no longer be supported by the increased
    global competetiveness in things like wage standards, etc., when there
    are other players such as China.  China itself will find this out in
    their own hard way as they mistakenly go down this same wrong avenue. 
    We arrived at this point fairly blindly.  But since most of us should by
    now realize this (and amazingly most still don’t or simply don’t want
    to admit it), we can only blame ourselves if we’re not able to adapt. 
    And by this I mean a change in standard of living, which can take many
    forms.  So many people who supposedly live at ‘poverty’ or welfare
    levels of income (a relative term in a global sense) quite likely have
    more gadgets, trinkets, unnecessaries than someone like myself, a
    middle-to-upper-middle class Canadian, has.  This computer is about the
    most sophisticated item I have.  I’ve been incrementally trying to stay
    afloat, not necessarily by increasing or maintaining my pre-conceived
    level of income, but by trying to highly reduce expenses, forego buying ‘stuff’, foregoing trips, etc.  I find a lot of fulfillment out of just
    tending to my garden, tending to a small flock of poultry/hens, foraging
    from the surrounding environment as opposed to the largely-import based
    local grocery store, and getting the kids engaged in real-life things
    as opposed to cyber things.  This lifestyle change, even foraging,
    extends into urban areas too, not just in the rural area where I live. 
    So a lot can be done to adapt even in urban settings.

    The ability and power to adapt lies not with our governments, but with
    the People on a collective basis.  And unless the masses here in N.A.
    (especially in the U.S.) come to realize this, and accept that much of
    the ‘American way’ simply has to be scrapped in place of a model that’s
    a lot more sustainable, no effort to reduce dept, quantitatively
    ‘easing’, etc. is going to come even close to saving our asses. 
    Governments and corporations respond to what happens among the majority
    of People, consumers, but have for a long time known that they can
    control what people do, because people are evidently a lot like cattle;
    easily led around.  And I’m certain that not nearly enough
    people will pre-emptively realize or accept this need to change, so
    nations like ours will learn the hard way, as we’re seeing happen this
    very moment.

    I can’t agree enough with K.cobley that it all links back to a flawed
    infinite economic growth model in a world of finite resources.  We DO
    need to be planning and managing for decline, not growth, and a big part
    of this requires a fundamental decrease in people’s perceived standard
    of living.  It can actually be done so that actual standard of living
    INCREASES, not decreases, providing that people accept that money is not
    the most important parameter defining one’s standard of living.

  • Rojelio

    It is our fault. I remember very explicitly Ross Perot warning us about free trade/offshoring in 1992 and we allowed the media to make a joke out of him. Ralph Nader has passionately warned us for years about what it might be like if corporations completely captured government and we’re still blowing him off even though this worst nightmare has come true. Ron Paul is trying to explain to us what is wrong with our monetary policy and he will be shafted by the mainstream as well. We’re so stupid that most of us think that this is a recovery and that exponential economic growth for 7 billion people is still possible.

  • the POOG

    I’m so tired of this theme. Think it through.

    Why does China
    have Treasuries in the first place? Because they had an enormous quantity of
    dollars due to trade with the US.
    A Treasury paying a fraction of a percent was better than a Federal Reserve
    note paying nothing.

    Suppose China
    can “dump” their Treasuries and receive the current price for them.
    What do they get in return? They get the dollars back that they just got rid
    of. (Hopefully a light went on there).


    Ask yourself how China
    “dumps” Treasuries into the market, particularly when China
    IS the market? Who’s buying them? Bill Gross? Some other central bank that can’t
    make the same computation about their real value that the BOC did? China
    would have to reduce their price to junk bond levels or lower. Even then, I
    doubt there are enough risk-takers to consume a trillion dollars of almost
    worthless paper.


    Actually there is one buyer waiting in the wings – the Fed.
    The Fed’s main monetary policy tool is control of interest rates. This is what
    QE2 was about and this is what QE3 will be about – further out the curve. They
    will buy whatever China
    “dumps” into the market to keep rates where they want them.


    Remember, if China
    yells ‘fire’ in the bond theatre, everyone dumps at once, both their Treasuries
    and the contents of their bowels. Watch Ben print! Watch the dollar collapse!
    Watch every other currency try to follow!


    It would be a truly amazing show, but it won’t happen.

  • Propensity6

    So oil goes below 90 dollars a barrel, Libyan production will soon be returning so Jeffy is now on another topic….JEFF, I thought we were going to have 200 dollar oil now…what gives…

  • Propensity6

    Jeffy, you are wrong…the Federal Reserve is the largest holder of Treasuries

  • Ffergie48

    The Republicans don’t dominate Congress, only the House of Representatives, while the Democrats control the Senate as well as the Presidency. The House of Representatives write the cheques.

  • Wvhaugen

    Donald Trump? Hahahahahaha!

  • Propensity6

    I can not believe that schools are giving degrees any more. The reason for China “financing” the US deficit is the artificially low exchange rate. Chinese companies sell goods to the US in US dollars, then need to convert their currency to the Wan and do so by giving these dollars to their banks. When the Chinese do not want any more US dollars, their exporters will lay off people by the tens of millions, China will go back to the dark ages and jobs will return to the US…but, it wont happen and things will go on as they are, until China is not given the privilege of a third world developing nations….then, there will only be maybe 20 million laid off as they will have to compete fairly