Bonds and the Dollar I

 (So what to do when foreign lenders won’t buy your US bonds? Devaluing the dollar forces foreign central banks to buy them in order to devalue their currencies, too.)

 October 3, 2010

We’re In a Global Currency War … But What Does It Mean?

As the Wall Street Journal writes: …

… The United States … despite running the world’s largest balance-of-payments deficit and also the largest domestic government budget deficit … has the world’s lowest interest rates and easiest credit. The Federal Reserve has depressed the dollar’s exchange rate by providing nearly free credit to banks at only 0.25% interest. This “quantitative easing” (making it easier to borrow more) aims at preventing U.S. real estate, stocks and bonds from falling further in price. The idea is to save banks from more defaults… A byproduct of this easy credit is to lower the dollar’s exchange rate – presumably helping U.S. exporters while forcing foreign producers either to raise the dollar price of their goods they sell here or absorb a currency loss.

(This) low U.S. interest rates and easy credit spur investors to lend abroad or buy foreign assets yielding more (and) this dollar outflow forces other countries to protect their currencies from being forced up. So their central banks do not throw the excess dollars they receive onto the “free market,” but keep them in dollar form by buying U.S. Government bonds. So the “Chinese savings,” “yen savings” and “Euro savings” that are spent on U.S. Treasury securities (and earlier, on Fannie Mae bonds to earn a bit more) are not really what Chinese people save in their local yuan, or what Japanese or Europeans save. The money used to buy U.S. Government securities consists of the excess dollars that the American military, American investors and American consumers spend abroad in excess of U.S. earning power. (It is the effort of foreign central banks to sanitize an excess influx of dollars.)

Accusations that Japan, South Korea and Taiwan are “making their currencies cheaper” by recycling their dollar inflows into U.S. Treasury securities simply means that they are trying to maintain their currencies at a stable level.

It is how most central banks throughout the world are responding to the global dollar glut. They are increasing their international reserves by the amount of surplus free credit” dollars that the U.S. payments deficit is pumping out