China’s Bond-Selling Strategy Is Working

I explained what’s going on in yesterday’s essay.

But there’s more to the story…

You see, foreign countries aren’t just buying fewer new U.S. Treasury bonds. They’re also actively selling the bonds they already own.

For example, China has been slowly cutting back its holdings of our debt for years.

As of March, China’s pile of U.S. Treasury bonds had fallen to $765 billion. The country even dropped from the second-biggest to the third-biggest foreign holder of our debt.

Why would China sell?

More Supply Than Demand for U.S. Dollars

Well, maybe the Chinese government is worried.

Perhaps China sees a government starting trade wars and piling up debt at a record pace. And in turn, maybe Chinese officials believe holding that government’s “IOUs” – U.S. Treasury bonds – doesn’t seem so safe anymore.

The move could be strategic, too. The U.S. is in an economic battle with China. So China could try to make things tougher by getting rid of U.S. Treasury bonds in droves.

What happens if a huge owner of something starts selling as fewer new buyers show up?

The price crashes.

That’s the key to understanding why the value of the U.S. dollar and the value of U.S. Treasury bonds have both fallen together recently. It’s a simple case of supply and demand…

When China sells a U.S. Treasury bond, it gets paid in U.S. dollars.

But the Chinese government can’t use U.S. dollars to pay their workers or build roads in their country. They need their own currency. So they sell those dollars on the open market.

That creates a flood of dollars. And when supply exceeds demand, its value goes down.

That’s why the U.S. dollar is weak right now. It’s not because of fears that the dollar will lose its reserve-currency status. (And even if it did, that would take years – not days.)

This last step is the most important one. When a massive player like a central bank sells huge amounts of U.S. dollars, it dramatically increases the supply of dollars in the market.

In this case, the “price” of the dollar is its exchange rate against other currencies. More dollars flooding into the market makes each dollar worth less.

The same thing is happening to U.S. Treasury bonds. Huge sellers like China are dumping them as fewer new buyers show up. So bond sellers need to cut prices to find buyers.

When bond prices fall, interest rates rise.

That means higher costs for the U.S. government to borrow. It could also mean higher rates for folks like you and me with our mortgages, car loans, and credit-card debt.

This isn’t a forecast for the U.S. government’s interest expense. It’s happening right now. And it’s causing a lot of people to worry about what might happen next.

However, it’s the normal course of business in the bond market.

Trust me, I’ve traded bonds for more than 20 years.

As I said yesterday, it’s worth knowing about this big cause of market uncertainty. I hope my explanation helps. And ultimately, my aim is to make sure you can protect yourself and your money.

Stay alert for more short-term uncertainty and volatility. The push and pull of the bond market isn’t always pretty.

But in the end, we’ll all be fine.

Good investing,

Pete Carmasino