The canary in the coal mine

And so it begins:

All told, the Treasury data is the latest signal that the dollar’s secular decline is eroding the value of U.S. assets, and prompting international buyers of U.S. debt to reduce their dollar-denominated holdings.

Russia’s selling isn’t terribly surprising given their recent public campaign to create a global unit of exchange, thus shifting away from the global economy’s reliance on the U.S. currency as an international reserve currency. But the buried lead in this story is Japan’s own eyebrow-raising decision to pare its Treasury holdings.  Bear in mind that Asia’s largest economy is normally a huge buyer of dollar-denominated assets, which it uses to manage the value of the yen. Japanintensely dislikes a strong yen, which undermines the competitive benefits a weak currency gives Japan’s export-reliant economy. 

With the precarious state of Japan’s economy – and the notorious penchant of Japanese authorities to monetize the country’s ballooning debt  – a weak yen is one of the few policy tools left to revive a stagnant economy. If Japan has now taken to selling its dollar assets, it’s not the height of speculation to conclude they might be sending the Obama administration a signal about its debt-heavy spending priorities.

Interestingly, China actually increased its holdings by 5 percent in May, according to the Treasury Department. Given that they are already the single largest international holder of Treasury securities, it’s not hard to imagine that they have precious few other options at this point other than to try and preserve the value of their $1 trillion investment. A sharp sell-off in Treasuries could well trigger a death spiral that would see the dollar weaken further and drive long-term yields to unimaginably stratospheric heights – a nightmare scenario the Chinese government is eager to avoid.

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