Treasury brand tarnished?

October 23, 2013 12:56 AM
Blog first appeared in DanCollinsReport on Oct. 23, 2013

Some editors of the John Lothian Newsletters were involved in a discussion of the U.S. Treasury “brand” over the last few days that I have also discussed and pontificated on recently.

Doug Ashburn asked, “Whether there has been damage to the U.S. Treasury “brand.” His conclusion was, “not just yet.”

Jon Matte basically agreed, saying, “The brand has survived the latest round of Russian Roulette, and I'll go one step further to suggest that the brand will continue to remain intact.”

Matte compared the situation to the game of Jenga and a house of cards and noted the risk of pulling out one of those cards.

Matte, of course, is correct but uses the words: survived, remained intact and Russian Roulette. That is not to say it wasn’t damaged.  I think the debate is a little off because everyone these days think in all or nothing terms. First off, I do think the brand was damaged. It couldn’t help but be damaged. That is not to say that China and Japan will stop buying U.S. Treasuries. The rest of world couldn’t stop even if they wanted to. But they may want to more today than say a month or two ago. And a reduction of say 5 or 10% is going to cause a problem.

A default, even a small technical one, would have done damage.

Doug Ashburn noted “…even the lunatic fringe politicians know how much worse off we would be if we were to lose our premier status.”

I challenge Doug to listen to some of the folks declaring the shutdown and debt ceiling fight a great success for those that initiated it. Sometimes, irresponsible folks can start something that they lose control over. There are folks in the media with large audiences (much larger than mine or even John’s) that are still arguing it could have been done — I have listened to these arguments in horror. Surely folks outside the United States have listened as well.

My point is, given all that it would only be prudent for foreign investors to look for ways to reduce their exposure to U.S. Treasuries. Not eliminate or even significantly reduce it but it is a mathematical equation like in an algorithmic trading program. The debt ceiling debate revealed a risk, perhaps a slight outlier risk but risk nonetheless and what a prudent risk manager does in that circumstance is reduce exposure, even just slightly. And this is occurring while the U.S. Federal Reserve is trying to return to a normal cycle by cutting back on the extraordinary stimulus that is QE3. They were banking on the fact that a U.S. economic recovery was building to a point that there would be a greater demand for U.S. Treasuries to replace its purchases. What they weren't banking on was another trip to the edge of a U.S. default.

Think of that for a minute. The central bank of the U.S. is preparing to end QE3 based on the notion that our economy is gaining strength so there will be enough demand for our debt to ensure the end of QE3 will not create a spike in interest rates while at the same time a significant minority in our Congress is encouraging that we default on some of our obligations.

I go back to a discussion I had with trading guru and famed gold bug Jim Sinclair when discussing the reserve currency status of the U.S. dollar.

He made the point that while there is no chance that the U.S. dollar lose its reserve currency status any time soon, “…as far as a settlement currency; weekly, almost daily, you see the dollar mechanism for settlement being replaced by other currencies. Especially by the internationalization of the Chinese currency. Nothing is going to replace the dollar, but it is the utilization and value that factor into markets.”

Get it, there are levels of faith in a currency. It is not all or nothing.

More recently he noted, “What no one is focusing on is the impact on future dollar sovereign investment appetite because of another close call at a default … The fact that things have gone as far as they have will make sovereign investors dollar cautious at a minimum and dollar phobic by some.”

He also pointed out a commentary by China’s official news agency where they suggested the world should consider ‘de-Americanizing.'

The point being that reserve currency status can be a matter of degree and the surety of U.S. debt is less than before. Perhaps when this comes up again in February our leaders can commit to fiscal responsibility without the threat of default, which could restore some lost faith. Too many of us in the United States believe the rest of the world just doesn't matter. We need to stop threatening them before they show us that they do matter.


About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.