The escalating rounds of tariffs between the United States and China is an interesting point of economic debate. However, from the perspective of the interest rate markets, it appears to be one of those subjects that generates a great deal of economist commentary, but with limited market impact. This view is arguably complacent; whether it is too complacent is left for the reader to judge....Bond Economics
Trade War Complacency
Brian Romanchuk
15 comments:
A more coherent analysis on the risks and reward to disengaging economic cooperation sooner rather than later with China. Including financial risks but broader context.
They don’t have to sell their Treasuries they could just let them run off (redemption) just like the Fed is doing...
If they just let them run off and the USDs remain in depository accounts the Dealers would have to take on 100s of billions of inventory they could never sell and we’re in GFC 2 as dealer-banks don’t have that much capital to hold 100s of $B of USTs in inventory.... risk based credit market would shut down until the Govt provided more capital to the dealer-banks...
Banks need not buy them. When China sells their USD to buy other currency someone else is buying USD and will buy Treasuries. Whether those are domestic or foreign, banks or investors, pensioners or savers makes little difference... people stuck with dollars want to earn interest.
They could just let them be redeemed and never authorize purchase of any additional....
Balances would remain in deposit accounts nobody else could buy them as China has the USDs in its accounts..
Dealers could take them on as inventory but would immediately violate the SLR and have to shut down the US credit markets... aka GFC 2....
At some point China will gradually convert its USD holdings to gold. It's the Asian way. Both China and Russia are building their gold reserves. Russia is being forced to de-dollarize owing to sanctions and threat of amped up economic warfare by the US. China is not blind to this. A trade war with China will just accelerate the time table on their de-dollarization.
There are no longer paper bonds so all treasuries -- bonds bills and n0tes are held at treasury direct. Dealers trade treasury issue serial numbers that have been registered at custody banks or the fed.
When a treasury is redeemed, the US Treasury issues a zero-percent certificate of indebtedness in a treasury direct acct. No taxes are collected in advance and no new bonds are issued besides the zero-c-of-i. This is a big change from boiler-plate MMT used in the MMT dog and pony shows. Nothing happens at the Fed or in the US banking system unless the holder chooses to convert the zero-c-of-I to US dollars and move the "money" to the banking system.
The process would go like this if China buys gold or euros or oil:
When China owned US T bonds are redeemed they get zero c-of-i. They issue instructions for US-Treasury to convert their balance to USD and the US Treasury dept either taxes or creates new Treasuries to obtain USD balances from other fed accts to fund the TGA in advance and then transfers from the TGA to ECB/National Bank of Belgium's Fed Acct. The ECB/National bank of Belgium then has a USD asset and the Bank of China Belgium branch has a claim on National Bank of Belgium. They order a boat load of oil and pay for the oil, so they transfer money to Exxon which reverses the process and ends with Exxon's Citi acct... and Citibank having an asset (claim on Fed) and Exxon having a claim on Citi. The real asset is transferred but the financial system carries on moving balances between private/bank/government accounts in the same boring way. Balances held in reserve accounts (Bank asset) at the fed don't have any risk. The Bank's liability to Exxon is a liquidity risk so the bank will have to hold some portion in their reserve account and it will count toward their overall "leverage" ratio since they are capital constrained but... the US government has already issued more treasuries so... no one really ended up with more US dollars in the banking system. I don't see drama or chaos looming or a dollar crash per-se except the value of the dollar is diminished if China no longer hodls dollars and actually spends them back into the economy.
Also of Note: When treasury pays interest, they don't credit bank accounts at the Fed, they create zero-c-of-i and increase the balance in a treasury direct accout. Nothing happens in any bank account anywhere.
(Unless you instruct them to "automatically" send those payments to a bank...)
“Balances held in reserve accounts (Bank asset) at the fed don't have any risk”
But banks still have to retain capital of 10% against those risk free assets.... so that is a designation without a functional difference...
If reserves skyrocket the banks are made insolvent EOS.... that was what happened in GFC 1...
China could cause the exact same thing to happen right now by directing their USD balances into depository accounts...
Banks don’t have enough capital to position China’s $1T+ on their balance sheets in a short time period...
Dumb policy, I don't know why they would have ever required capital cushion on risk free assets. Value at risk on a short term treasury is nil, so even if they have to hold capital against the risk adjusted "interest rate risk" value, it seems silly. When banks approach their leverage ratio they should require the banks to buy these risk free assets until they raise capitall. When they had dodgy custodians who were lax in their record keeping, yes, treasuries were risky and posed systemic risks, but I doubt it now. If the treasury securities are registered for use as collateral in the bank's fed account, there is literally no way that the bank ever gets hurt because they can borrow against their value and never have to sell the security. EVER. So there is no interest rate risk from early sale.
It looks to be the similar to required reserves. They apparently assume the money multiplier and think bank reserve assets function similarly to bank loan assets?
Yes Tom the Chicomms probably won’t do it because they think they would be HELPING the US by providing more “deposits to lend out”...
Rumor has it that China has now stopped buying US tsys.
Probably balances building up in those zero interest Treasury Direct accounts Ryan identified above if so Tom...
If they request start to transfer into depositories we may be toast....
I am pretty sure they will only transfer funds from their Fed account for spending.
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