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Investing in U.S. Government Debt

Why Gold is the ONLY Safe Haven

Written by Geoffrey Pike
Posted December 19, 2014

The latest report detailing foreign holders of U.S Treasuries shows that China has been slightly reducing its holdings of U.S. government debt. Its holdings are the lowest since February 2013.

As of October 2014, China reported holdings of $1.25 trillion in U.S. debt. In October 2013, China’s holdings were approximately $1.30 trillion.

It would not be accurate to say that the Chinese government/central bank is selling U.S. Treasuries. After all, there is maturing debt where they receive the principal amount back. So it appears China is still buying debt — just not enough to effectively roll over the expiring debt.

If China or anyone else simply stopped buying Treasuries, including rolling them over, then its holdings would slowly go down as the debt matures and eventually goes to zero.

Meanwhile, Japan has actually been increasing its holdings. In October 2013, Japan held $1.17 trillion in U.S. government debt. The latest numbers for October 2014 show holdings of $1.22 trillion, an increase of over $100 billion over a one-year period.

China still holds the highest dollar amount, but barely. After China and Japan, Belgium is the next-highest holder with “only” $348 billion. Of course, this doesn’t count the Federal Reserve, which is by far the biggest holder of U.S. debt.

In other words, China and Japan are the big players. The central banks of both countries are on a digital money-printing spree right now, but apparently China is finding better things to buy than U.S. government debt.

Who is Buying the U.S. Government’s Debt?

While the total foreign holdings of U.S. Treasuries have increased over the last year, they have stayed relatively flat over the last couple of months. This is interesting for the mere fact that long-term interest rates have been going down again.

The Federal Reserve wrapped up its latest round of so-called quantitative easing (monetary inflation) at the end of October. But even in October, the Fed was only purchasing about $15 billion in assets, which included mortgage-backed securities.

So the question is, why are interest rates going down?

This has to mean there are buyers for U.S. Treasuries and bonds.

The Fed is no longer buying. China is reducing its holdings, even if slightly. Japan’s holdings, while increasing year over year, were reduced slightly in the last couple of reported months.

China has been purchasing some longer-dated U.S. securities this year as short-term securities mature, but it would not fully explain the recent drop in interest rates.

The only explanation is that private investors are buying U.S. bonds. It is not the central banks buying on net. In particular, investors are buying longer-term bonds.

This should give us caution on where the economy is headed. While I don’t view the dollar and U.S. Treasuries as safe havens, investors historically buy U.S. Treasuries in times of turmoil. The only exception seems to be when there is high price inflation, as was seen in the 1970s.

The 10-year yield is down to almost 2%, which indicates that the yield curve is flattening. When investors seek to lock in longer-term interest rates, it is a sign of a recession. With short-term rates near zero, we probably won’t see an inverted yield curve as we have seen so frequently prior to other recessions. We may just see the yield curve somewhat flatten.

In addition, it is interesting that the price of oil has gone into virtual free-fall at the same time that long rates have been going down. While some of this is certainly attributable to increases in supply (or potential supply), I can’t help but think there is a weakening in foreign demand, which indicates a worldwide slowdown.

Bad Economic News Everywhere Else

Americans — even American investors — tend to not pay a lot of attention to what is happening in foreign economies. Some might look on with curiosity, but it doesn’t typically affect their opinion of the U.S. economy.

In the past, this was rational thinking. It actually was quite possible to see a virtual worldwide economic slump while America continued in prosperity.

But we live in a more global economy now than ever before, and the U.S. depends on foreign trade quite a bit. In addition, the U.S. government also depends on foreign central banks to continue buying its debt, which is unfortunate. This wouldn’t be necessary if the federal government balanced its budget.

China and Japan in particular have subsidized the American consumer by buying U.S. debt. It keeps prices down for Americans. The downside for Americans is that it also enables the U.S. government to run up massive amounts of debt at low interest rates. It is almost the equivalent of welfare, which can be harmful in the long run, even for the recipient.

Currently, Japan is in a deep recession. Some would say it is despite the Bank of Japan’s massive monetary inflation and the Japanese government’s massive spending and debt accumulation, though I believe it is because of these things.

Western Europe is a mess, too. Many countries are in deep recession (or worse), and they continue their Keynesian policies and massive welfare states.

China is not technically in a recession, although there are indications of a slowdown. It is always hard to tell what exactly is going on there because of the shady statistics and the huge distortions. The stock market in China is booming. We know the real estate market has boomed. The country is set up for an historic crash, but it could still be a while before we see that play out.

If and when the Chinese economy tanks, it will be interesting to see if the Chinese central bank continues to buy U.S. government debt. Perhaps that would be the beginning of more significant reductions in holdings of U.S. Treasuries.

What to Watch For

China and Japan are the two major players to watch. This is important in both the short term and long term.

In the short term, if holdings of U.S. debt decrease and interest rates keep going down, then this indicates private investors are buying U.S. debt to lock in interest rates. This indicates a recession is coming.

I advocate that you set up a permanent portfolio for the majority of your financial investments to protect your wealth against any adverse events that you can’t predict. This would include another major recession in the United States.

In the long term, we must also watch Japan and China with their holdings of U.S. debt. I don’t believe the U.S. dollar is going to lose its status as the world’s reserve currency until these countries, particularly China, start significantly reducing their holdings of U.S. debt.

Once the U.S. dollar loses more respect in the world, gold is going to shine. The world has already turned its back on the other major currencies, including the yen, the euro, and the yuan. The dollar is strong only because everything else is weak.

While private investors currently flock to U.S. Treasuries paying a return of about 2% over 10 years (before taxes), there will come a time when investors realize gold is the only safe haven. It cannot be made on a printing press.

Until next time,

Geoffrey Pike for Wealth Daily

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