Who Will Buy Treasuries If China Does Not? Lots Of People

from Jeff Miller

There are multiple reasons, but the most important is rarely mentioned. Stories ask, “Who Will Buy Our Bonds?" as if China is the only market. The (overly) simple heuristic is a market with a handful of participants. Country A borrows from B. B calls the debt. Party A must now, hat in hand, go to C or D or E to ask for a loan. This analytical error comes when we focus on the result of building and liquidating positions instead of daily market dynamics. What is the correct answer to the “who will buy" question?

The buyers will be the millions of individuals (usually through funds) and thousands of institutions that are bidding for US Treasuries every day. Some currently lose out in purchases to Chinese buyers, perhaps because of China’s compelling need to invest US dollars. An economist might instead ask: 

Suppose a buyer who is relatively insensitive to price was subtracted from the demand curve. What would be the new market clearing price? 

This question allows the analyst to include the deep and liquid Treasury market and therefore see the minor effect of trading by even the largest participants.

This basic market analysis is ignored by everyone. I guess it is too sophisticated for the pundits, who personify everything, and too trivial for real economists.

Here are some other reasons: 

China has a current account surplus with the US. That means that the result of trade is an influx of dollars. They must do something with those dollars. Treasuries are a convenient and liquid choice, although they hold US equities as well. (CFR). 

China seeks the best investment for its dollar surplus. US Treasuries are better than the negative-yield European choices. US Stocks are attractive relative to US Treasuries. 

A serious reduction in US investment would require currency appreciation to reduce the current account surplus. This would threaten employment. 

Investment Conclusion

Algorithms programmed for trade war and China bond selling can take control at any time. The average trader is using a simple heuristic. Noted bond managers just feed the flames of worry.

The astute long-term investor knows how to quantify potential issues and take advantage of headline-driven headlines.

Further reading, including Treasury market data, analysis, and discussion willbe posted tomorrow.