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Buy Bonds! Chinese Rock Meets Economic Hard Place

Recently, Nobel Prize-winning economist Paul Krugman told an audience in Beijing that the US risks having a "lost decade" of Japanese-style economic stagnation because of the Obama Administration’s "half-measures," most notably a stimulus that was too small and will, in his opinion, need soon to be repeated.

I wonder how his remarks went over with that audience. The problem is that the stimulus requires America to borrow an awful lot of money, which in recent years has largely been made possible by China’s buying up American currency and Treasury bonds. And that’s something the Chinese are apparently no longer willing to do:

U.S. debt prices slid, sending the 30-year Treasury bond yield to its highest since November.

"The auction is big news because now it’s showing that maybe the Chinese don’t want our bonds. If the cost of capital for the United States becomes more expensive, then the recession is going to take that much longer to get out of," said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey.


The $14 billion Treasury bond auction met below-average demand from investors, who bid aggressively to force the government to pay a higher yield as it pushed ahead with plans to help finance its burgeoning budget deficit with more longer-term debt.

Now, it’s likely that fears of China leading the world’s other economies to dump the dollar are exaggerating the reality of the situation; as has been noted, China tried using a currency basket in 2005 but has essentially dropped it now that the going’s got tough; it was forced to intervene last fall to keep the yuan from rising so much it killed off their already-ailing export industry. Meanwhile, the dollar is a model of stability compared to other foreign currencies, which is why so many investors worldwide are flocking to it. However, that still doesn’t mean the US has an unlimited rein when it comes to deficit spending. It looks like Obama has to steer very carefully between a rock and a hard place to get us past the economic shoals.

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