China Thinking About Selling US Securities: Disastrous Scenario For US Debt Picture

Imagine China starting to sell treasuries while the Fed is vigorously trying to hide the fact that the auctions are failing by using anonymous direct bids into the treasury auctions. Then the claims that foreigners were buying the treasuries would be falsified as no one is really buying the treasury securities any longer. There would be huge dislocations in the markets. The rates would have to go through the roof. The dollar would tank. Stock markets would crash. Gold would fly through the roof except for heavy manipulation by the Fed and even in the face of it it might fly through several thousand dollars anyways. This would be the end of the dollar as the reserve and global trade currency as well as the beginning of the end of fiat paper monetary system.

Here is an article from Barron's:

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UP AND DOWN WALL STREET

  | WEDNESDAY, FEBRUARY 10, 2010

The Debt Contretemps Everybody's Ignoring

By RANDALL W. FORSYTH | MORE ARTICLES BY AUTHOR

As markets focus on little Greece, U.S.-China tensions escalate.

WHILE GLOBAL MARKETS WERE TRANSFIXED by the Greek drama, a potentially far more important clash of governments may be brewing in the debt markets.

China may be preparing to sell some of U.S. securities for financial or geopolitical motivations, or a combination of the two, according to two different accounts.

Reuters reported Tuesday that senior Chinese military officials suggested that nation sell some U.S. bonds to punish the American government for its latest sale of weapons to Taiwan.

Moreover, David Goldman, writing on the Inner Workings blog at the Asia Times internet site (www.atimes.com) wrote the Chinese government has ordered reserve managers to divest themselves of all U.S. securities that aren't backed by the implicit or explicit U.S. government, which would leave only Treasuries and certain U.S. agency securities. That would cover Chinese institutions' substantial holdings of U.S. corporate and asset-backed securities.

The financial relations between the world's largest debtor, the U.S., and the world's largest exporter and creditor, China, have become increasingly contentious. But as with many an unhappily married couple, they can't live with each other and they can't live without each other.

In the past year, Beijing has called for a substitute for the U.S. dollar as the world's main reserve currency and has upbraided Washington for its fiscal and regulatory management. And while Treasury Secretary Timothy Geithner asserted last weekend that the U.S. government would never lose its triple-A credit rating, last year Chinese students openly laughed at his assertion that U.S. securities were safe.

Meanwhile, the U.S. has hectored China about the alleged undervaluation of renminbi, which has effectively been fixed versus the dollar since just before the Beijing Olympics in August 2008. In addition, the U.S. has imposed protectionist measures, including the imposition of increased tariffs on Chinese-made tires.

The latest reports of China's possible curtailment of purchases of U.S. securities could represent a serious escalation of economic and political tensions between the two nations.

Dumping of U.S. assets as retaliation for America's support of Taiwan represented just one of a series of "counter-punches" covering politics, military affairs, diplomacy and economics that Beijing could employ "to treat the symptoms and root cause of the disease," as Reuters quoted a Chinese research at the Academy of Military Affairs.

The alleged use of U.S. securities as a geopolitical weapon is not without precedent. According to the recently published memoirs of former Treasury Secretary Hank Paulson, On The Brink, Russia urged China to sell its Fannie Mae (FNM) and Freddie Mac (FRE) securities in 2008 to force a bailout of the mortgage giants. The Chinese declined at the time, Paulson wrote.

Now, it appears China is becoming more assertive.

David Goldman, a former Wall Street research director who remains very plugged into market action and who is no stranger to readers of this column, reports the Chinese government has ordered its reserve managers to divest itself of U.S. securities riskier than Treasuries and agencies such as Fannie and Freddie. "This already has been communicated to American securities dealers, according to market participants with direct knowledge of the events," he writes.

David continues: "It is not clear whether China's motive is simple risk aversion in the wake of a sharp widening of corporate and mortgage spreads during the past two weeks, or whether there also is a political dimension.

"With the expected termination of the Federal Reserve's special facility to purchase mortgage-backed securities next month, some asset-backed spreads already have blown out, and the Chinese institutions may simply be trying to get out of the way of a widening.

"There is some speculation that China's action has to do with the recent deterioration of U.S.-Chinese relations over arm sales to Taiwan and other issues. That would be an unusual action for the Chinese to take -- Beijing does not mix investment and strategic policy -- and would be hard to substantiate in any event."

That may be, but the Reuters dispatch indicates the Chinese military is inclined to mix the two. To be sure, that does not mean they hold sway in such matters.

Nevertheless, just as the Greek crisis indicates, when government indebtedness becomes big and burdensome enough, its importance can transcend economics and enters the realm of politics.

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