Why it matters that foreign investors are selling U.S. government bonds

Investors traditionally have bought U.S. Treasuries on the assumption that, no matter what, the U.S. government will be there and will stand by its debts, says The New York Times.

But turmoil in the bond markets last week showed the extent to which President Trump’s trade war has damaged American credibility as a responsible steward of peace and prosperity, the Times says.

“The whole world has decided that the U.S. government has no idea what it’s doing,” says Mark Blyth, a political economist at Brown University and co-author of the forthcoming book “Inflation: A Guide for Users and Losers.”

The Trump administration promotes tariffs as bringing manufacturing jobs back to the United States, saying short-term turbulence will be followed by long-term gains. 

“But as most economists describe it, global trade is being sabotaged without a coherent strategy,” the Times says. “And the chaotic way in which tariffs have been administered — frequently announced and then suspended — has undercut confidence in the American system.

“For years, economists have worried about an abrupt drop in the willingness of foreigners to buy and hold United States government debt, yielding a sharp and destabilizing increase in American interest rates. By many indications, that moment may be unfolding,” the Times says.

“For Americans, that reassessment threatens to revoke a unique form of privilege,” says the Times. “Because the United States has long served as the global economy’s safe harbor, the government has reliably found takers for its debt at lower rates of interest. That has pulled down the cost of mortgages, credit card balances and auto loans. And that has allowed American consumers to spend with relative abandon.”

“At the same time, foreigners buying dollar-denominated assets pushed up the value of the American currency, making products imported to the United States cheaper in dollar terms,” the Times says.

“Critics have long argued that this model is both unsustainable and destructive,” says the Times. “The flow of foreign money into dollar assets has permitted Americans to gorge on imports — a boon to consumers, retailers and financiers — while sacrificing domestic manufacturing jobs. Chinese companies have gained dominance in key industries, making Americans dependent on a faraway adversary for vital goods like basic medicines.”

When large numbers of investors sell bonds at one time, that forces the government to offer higher interest rates to entice others to buy its debt. And that tends to increased interest rates throughout the economy — for mortgages, car loans and credit card balances.

Last week, the yield on the closely watched 10-year Treasury bond increased to about 4.5 percent from just below 4 percent — the most pronounced spike in nearly a quarter century, according to the Times. 

At the same time, the value of the U.S. dollar has been dropping, even though tariffs normally would be expected to push it up.

Other factors are at work in the sell-off, the Times notes. Hedge funds and others have sold holdings as they exit a complex trade that seeks to profit from the gap between existing prices for bonds and bets on their future values. Speculators have been unloading bonds in response to losses from plunging stock markets, to amass cash to stave off insolvency.

And some people fear that China’s central bank, which has $3 trillion in foreign exchange reserves, including $761 billion in U.S. Treasury debt, could be selling as a form of retaliation for American tariffs.

For years, foreign holders of U.S. bonds have wanted to diversify into other storehouses for savings. But the dollar and U.S. government bonds have maintained their status as the ultimate repository, the Times says.

“If the Europeans decide to issue a ‘sanity bond,’ the world might jump at it,” Blyth says.

The Chinese government long has wanted to elevate the place of its currency, the renminbi. But foreign investors don’t see China as a having sufficient transparency or rule of law, limiting its utility as an alternative to the United States, says the Times.

So, for now, the Times says: “The old sanctuary no longer seems so safe. Yet no other place looks immediately capable of standing in.”