China Reduces Treasury Holdings

Front and center today, the TIC flows data from June was very interesting yesterday… Before we get into this, let me explain what I'm talking about for the new “kidsâ€? in class… TIC stands for Treasury International Capital, and it's just a fancy way of saying that someone is tracking the net security purchases… Why is this important? Well, security purchases by foreigners is how the US finances its ever growing deficit. For example, the trade deficit and foreign direct investment makes up the current account… But just to keep this simple, the trade deficit in June was $49.9 billion… The net security purchases to finance that deficit in June was… $44.4 billion…

So, we were net negative in financing in June… What happens now? Well, we kick the can down the road even further… The US rolls this negative forward… How long can it do that? Well, it can do it as long as foreigners keep lining up to buy… Not until foreigners say “no masâ€? does it all come crashing down…

So, what's the big news from the TIC data yesterday besides the fact that we were negative in June? Well… And this is for the guy that keeps writing me telling me I'm wrong about China… According to Bloomberg, China cut its holdings of Treasuries by the MOST EVER in June! Total Chinese investment in US debt declined 2.8% in June, following a 3.6% slide in May…

You might recall that it was in June when China made the announcement that it would once again allow more flexibility in the renminbi (CNY)… Hmmm… You don't think… Nah… That couldn't happen, could it? Well, yes it could! China could have very well decided to allow more flexibility and reduce its reasons for buying Treasuries… Turning instead to Europe and Japan… It's all there in the TIC report…

I haven't always agreed with economist Art Laffer, but when responding to a question posed to him about China taking over the #2 spot in the world's economies, he said, “China is not our enemy.�

We need to remember this… China has to do what's best for China, just as the US does what's best for the US…

So, let me go through this exercise on what happens when the deficit financing comes crashing down… The government has two choices… It can aggressively raise interest rates to make the Treasuries attractive again, or it can allow a depreciation of its currency, which acts as the “clearing mechanismâ€? for trades. In the latter case, if the dollar is much weaker, then when foreigners buy Treasuries and convert their base currency for dollars to purchase the Treasuries, they get to buy the Treasury at a “discountâ€? because of the weakness of the dollar.

Which one do you believe the government will choose? What's behind door number one? Or door number two? One brings your economy to its knees, and two deep-sixes the purchasing power of the currency…

Which one do you believe the US will opt for, given the current state of the economy?

OK… Now that we've gone through all that… The dollar is weaker this morning, along with Japanese yen (JPY) and Swiss francs (CHF), which tells me that so far, in the Asian and European sessions, it's been a “risk onâ€? day. Stocks in Asia and Europe did well overnight, and US stock futures are up, so one would have to think that this dollar weakness would continue once the boys and girls in New York arrive with their Starbucks, and begin their trading days.

The euro (EUR) briefly traded above 1.29 overnight, as the results of an Irish bond auction were not as bad as some feared, but then was smacked back below 1.29 when German investor confidence, as reported by the think tank ZEW, dropped more than forecast to a sixteen-month low this month. I would have to think that this drop in confidence stems from the recovery of the euro during June and July. For those of you keeping score at home, check your scorecards; they will show that the euro recovered from a low of 1.1877 on June 7th, and ended July at 1.3179…

Why would Germans get all jiggy with a strong euro? Well, you see, Germany is a manufacturing country, and depends on exports, and those exports suffer when the euro begins to gain against not only the dollar but other currencies as well.

The Aussie dollar (AUD) is back above ninety-cents this morning… I truly believe the “lightâ€? went on for traders yesterday who realized that the Aussie dollar was below ninety-cents but had one of the highest interest rates/yields in the world… And while interest rate differentials are not the “end allâ€? of currency valuations, they do go a long way toward attracting investors, and after all, isn't that important? You bet your sweet bippie it is!

Unfortunately for the Aussie dollar, the Resave Bank of Australia's (RBA) meeting minutes lead me to believe that the RBA is finished raising rates this year, unless data demands they do so… Given the softer nature of recent economic data from Australia, I would have to say, chances are slim and none (and Slim left town) that the RBA will hike rates again this year… But… They've already done quite a bit of hiking rates this year, so I don't think the Aussie dollar will suffer from this revelation.

So… The Swiss franc spent one-day trading with a better figure than the Canadian dollar /loonie (CAD) versus the US dollar. But oil is trending back up again, after dropping big time last week, and once again the loonie is in favor with traders.

In recent days, gold has traded alongside the likes of dollars, yen and francs… So, one would expect gold to be getting sold this morning, alongside those currencies, as risk aversion takes a back-seat today… But, as I look at the screens, gold is up $1 this morning… Hmmm… Gold is at a six-week high this morning, and I think this is where gold takes the high road, while dollars, yen and francs take the low road. And as I've always said, I thought a rising gold price would occur when investors realized the economy in the US was a house of cards, and investors would need to protect their wealth…

I don't want to slight silver, so don't forget about silver as a protection of wealth too!

And then finally… I love it when I see the likes of Norway rally, for Norway is so fiscally sound, and its fundamentals are above and beyond most countries. Conversely, I also cringe the most when I see Norwegian krone (NOK) weaken… Norway is too caught up in what the other European currencies are doing and shouldn't be… I think of Norway like I always told my kids when they would say, “But dad, the other kids are doing it.â€? I would tell them, “But, don't you want to be better than the other kids? I sure expect you to be!â€?

Then there was this… One thing I want to bring to everyone's attention…

I get emails throughout the day with questions as to what's gone on to move the market in a direction that day.

There's a way you may have instant access to currency news throughout the day, by simply going to our website and clicking the “Research & Planningâ€? tab; then click “Currency Newsâ€? in the drop down box. Try it… I think you'll like it!

Chuck Butler
for The Daily Reckoning

China Reduces Treasury Holdings originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."