It took a couple of minutes, but I finally came up with a couple of scenarios whereby Deutsche Bank’s prediction of China overtaking the US by 2020 might come true.

Scenario A: China grows in real terms by 13.5% p.a., the US by 0.5% p.a.
Scenario B: China grows in nominal terms by 13.5% p.a. and at the last minute revalues by 23%; and the US grows by 0.5% p.a.

Can’t seem to get to the 2020 date any other way.

basically, the 07 survey proved to be a bad guide to the 08 survey. in 08, Russia and Japan were larger buyers through the UK than I expected, and China was a smaller buyer — i.e. the 07 survey was an imperfect guide to the 08 survey.

china incidentally accounts for a larger share of the Agency flow through HK and the UK than of the Treasury flow.

Were you misquoted by the Economist article or will the following information be clarified in your updated paper on China’s 1.7 Trillion Bet? In the Economist article it states that 30% of treasury purchases were made through London from 2006. Yet on page 12 of your January 2009 paper, it almost doubles that number to 59 percent. Has the data changed?

The USG is indeed playing ‘chicken’ with just the kind of downward, self-reinforcing spiral you outline.

They’re putting the proverbial microphone ever closer to the speaker, hoping to get a controlled, short-lived screech out of the sound system, a screech that livens up the presently dead securitization party again. They are assuring everyone that they can manage things to keep the ‘screech’ from becoming an ear-deafening howl that swiftly blows out the amp.

Maybe they can manage it. But very likely, they can’t as well as they think they can. As someone here said, it’s an experiment, but with gargantuan stakes and risks. Someone else here asked what choice they have? None I can think of, none that are viable or acceptable.

QE, where you issue new debt and then just print money to buy it up yourself, is dangerous for the reasons you outlined. Dangerous self-reinforcing feedback scenarios that aren’t easily controlled can get started.

Any other scenario would be unreal. To continue along this line of thinking, a rational market would demand a real return. Since all interest rates should go up with t-bond rates, we kill old mortgage paper(and the banks and investors holding it) and new mortgage rates go up, killing housing prices more.

The Fed could try and buy all debt past and future, but we would get a currency crisis along the way. By now private capital is wiped out.

The final hypothetical endpoint is the Fed and Treasury IS the financial system and the US is the only country that uses Dollars. In other words, we become a perfect communist country…by accident.

However, the Fed wants to keep Treasury yields low to keep mortgage rates low to help support the housing market. The Fed also wants to avoid deflation at all costs. Therefore, the Fed will continue buying USTs, and China buying fewer USTs just means the Fed has to buy commensurately more to keep the yields at the same low level.

At some point, that could mean more than just mild inflation. It could mean inflation in excess of 3%. If the 10-year Treasury yield is kept below 3%, then that implies a negative real interest rate on the long end.

I guess my question is, is this possible to achieve, in practice? Or would investors just dump their Treasurys (why hold onto something with a negative real yield), thereby pushing the yield up? And if the Fed responded by buying more aggressively, then that would increase inflation expectations even further, making the Treasury yield even more negative, causing more investors to sell, basically causing a downward spiral. In which case, the Fed would lose the ability to sit on the yield curve at the long end.

Is this a real scenario? How would things likely play out? In addition to the Chinese buying fewer Treasurys, one could posit other phenomena (like peak oil causing inflation again) that could jeopardize the Fed’s control of the long end.

Thanks,
Raj

But timing this is difficult. The Fed is going thru an experiment right now with $300B of QE in an attempt to find out how long the fuse is before it lights something on fire, and what that something will be. Some people think the Fed will try printing far more than $300B.

The Japanese did $300B of QE around the 2002 time frame. They are about half the size of the US economy. The results were kind of like a dud going off, a tiny impact in reversing stag-deflation. But Japan was a net exporter, and has a high personal savings rate and large private savings pool.

So past performance in Japan does not reflect future performance in the US. However, there are now concerns about whether the Japanese government is “solvent”… er, I mean can it service and/or roll over its debt in the future.

And we know in the case of the US, we are now more and more t-bill financed than t-bond financed, so we are like a hedge fund(Treasury) with the backing of a Pawn Shop (Federal Reserve balance sheet assets) that is lucky enough to have a printing press with plates that pump out a reserve currency!!!!

So put that in your hookah and smoke it. Your forcasting ability will be just as good as a Cray computer running an economic model.

On the other hand, this last month I made 10x more with my double t-bond short than I would have made being “long” and collecting the interest. Still I do worry that we may print some deflationary econ data later this year that may present some bumps in the road to a short position.

This analysis doesn’t work because all governments are insolvent.

Indian: My calculation is that the US Treasury is hardly able to meet its obligations towards healthcare, Medicare and social security out of its receipts.

And none of this matters because governments can raise taxes or print money. You need to look at the degree to which the US can raise taxes (and it could raise them quite a lot) or print money (which in the case of the US is infinite).