The real meaning of US Treasuries
What is the real meaning of U.S. Treasuries? They are the world’s money. The world depends on U.S. Treasuries to provide a reliable source of money. Congress’ threatening to default on the debt is like divorced parents fighting in front of their kids and saying bad things to the kids that criticize the other parent, which is bad for the kids to hear. The foreign investors in U.S. Treasuries are like dependents, who in this case, depend on the U.S. Treasuries to be a reliable source of “money” that investors can believe in. It is urgent to maintain the credibility of the debt.
Of course T bills are not money in the sense that a consumer can’t spend them in a retail store. But they are money in the minds of giant foreign institutions that need a store of value that is far too large for the FDIC $250,000 bank deposit limit. If China put all of its $3 trillion foreign currency reserves into individual U.S. commercial bank deposits with a $250,000 FDIC limit on each account they would need to use 12,000 different banks. That would be a confusing and inefficient way to hold money.
Any action or threatened action by Congress to renege on the Treasury debts would essentially damage the world’s money, which would then damage world finance, trade, banks, and stocks. The U.S. has been called the policeman of the world that tries to stop wars and invasions and restore order in failed nation states. An analogy to that is our currency and Treasuries perform a role the world depends on, is addicted to, and has no real alternative to and that is the dollar’s role (in the form of Treasuries) as the world’s piggy bank. If you are a nation with several hundred billion of spare cash you will be used to buying Treasuries as a form of putting money into a piggy bank to hold spare cash until you can invest it. Ironically a moderate increase in the world’s supply of Treasuries is good for the world because as the world economy grows it has more money to deposit into a reliable bank. A shortage of Treasuries to invest in has been known to contribute to financial problems in other countries.
It is the social responsibility of the U.S. to avoid damaging its reputation about its debt because this could lead to destruction of the world’s money. Since a Treasury is simply a piece of paper (actually an electronic record) then it is very important for investors to believe in it and not have their confidence shaken. Essentially investors’ faith in an intangible like a Treasury Bill is like someone in a trance. If a sudden, shocking distraction occurs the person in a trance may wake up and stop his current habit and do something different. In this case it would mean foreign investors would abandon the dollar and invest in other currencies. A country with a broken monetary system would suffer from a drastically higher cost of capital leading to a damaged stock market, damaged 401k’s, greatly reduced trade, reduced growth and less employment.
When the dollar declined against the currencies of commodity exporting nations like Peru the Chinese government traded some of their dollars for Peru’s Sol currency. However, I think Central Bankers are reluctant to trust a non-brand name Emerging Market country’s currency. It is far safer, in terms of Central Banker’s office politics, to play it safe and invest in G-7 currencies, except that European Union and Japan have massive problems so that leaves the dollar as the world’s money. Since it would be absurd to invest in actual paper currency or small bank deposits then Treasuries are the world’s money. There is so little gold in the world that the world can’t put all of their funds into buying gold.
Yes, it is wrong for Congress and the President to keep on spending excessively. But it also wrong to cause a debt crisis by refusing to raise the debt ceiling. And two wrongs don’t make a right. If the Republicans want to reduce spending then fine, simply go out and campaign for it and see what the public thinks about getting less benefits from the government. The way to campaign for less spending would to send the message that cutting expenses is the only way to have a solvent, reliable government lockbox to protect the programs that you depend on, since an insolvent government can’t pay for programs and benefits. Politicians shouldn’t try to cut spending by holding the debt ceiling legislation hostage until they get what they want because that can lead to a global economic panic like what happened when Lehman went bankrupt in 2008. Yes, if the debt ceiling was not raised the government could take tax revenue and use it to pay the debt service first to avoid default, but the other unfunded, paralyzed government functions would result in a risky and awkward process. This would cause panic and speculation that the government might be tempted to default on Treasuries in order to take care of government functions. The uncertainty induced would imply a decline in the dollar and a shocking increase in interest rates, thus damaging the economy.
I have written an article “Two things you must know how Debt Ceiling crisis hurts 401k’s”
Investors should seek independent financial advice.