Thursday, December 26, 2013

Possibility of higher interest rates

The Chinese made a blockbuster statement that was summarily ignored. Last week, a deputy governor of the People's Bank of China said that buying foreign exchange reserves was now no longer in China's national interest. The implication that China may no longer be accumulating U.S. government debt would amount to the "mother of all tapers" and could create a clear and present danger to the American economy. 

But the story barely rated a mention in the American media.  Over the past decade or so, the People's Bank of China has been one of the largest buyers of U.S. Treasuries (after various U.S. government entities that are essentially nationalizing U.S. debt). China currently sits on $1 trillion or more in U.S. bond obligations.

So, just as many expect that the #1 buyer of Treasuries (the Fed) will soon begin paring back its purchases, the top foreign holder may cease buying, thereby opening a second front in the taper campaign. This should cause any level-headed observer to conclude that the market for such bonds will fall dramatically, causing severe upward pressure on interest rates. 

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