Is America’s Funding Holiday Over?

For the past several years, saver nations in the emerging world, led by China, have been using their balance of payment surpluses to buy US Treasuries, however it looks like this policy may have come to an end.

As of the end of December (the last available data), the total value of US Treasuries held by foreign central banks was below the level reported back in September. While the drop is only small, its significance should not be understated.

According to Russell Napier, author of the excellent book Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms, “From the peak of the last business cycle right up until last summer foreign central bankers brought 45% of the issuance, they brought $2.2 trillion worth of Treasuries, and now we are looking at a period where they’re just not buying any.”

This reversal in policy is being led by the People’s Bank of China (PBOC) which is now a net seller of US government debt. According to data from the US Treasury the PBOC sold $100 billion in December alone, and while other central banks are still buying, on aggregate Treasury purchases in the last quarter of 2011 were flat.

This is a significant change in trend, and if it continues, it will have serious implications for the United States, and potentially other debtor nations such as the UK and Japan. Effectively this trend change means America’s funding holiday is over and they must now find a way to finance there profligate spending internally.

So what does this mean to investors? Well, it likely means that credit is dying, certainly we are seeing more and more signs of it, and when credit dies, deflation typically follows. However as I’ve written about before deflation simply will not be allowed to take hold. Instead, I expect inflation and plenty of it.

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