Who Is Buying U.S. Treasuries?

David Galland, Managing Director

Dear Reader,

We’ve aggressively been advising readers to accumulate gold as a portfolio keystone from the very onset of its current secular bull market in 1999. 

It has been our thesis, looking at a landscape littered with easy money and out-of-control government spending, that the piper had to be paid – in funny money.

How things have changed from when we were nearly a lone voice in the woods – with the list of institutional gold buyers growing longer with each passing day. Of those institutions, none is more important than the central banks. That’s because, collectively, they are the world’s single largest institutional holders of above-ground gold, and by a wide margin.

During gold’s long bear market hibernation, which lasted from 1980 to June 1999, the central bankers looked upon their gold holdings with something akin to embarrassment, happy to lend it out for small change or to sell some to raise a bit of cash. 

Most famously, then-UK Chancellor of the Exchequer Gordon Brown sold off half of Britain’s gold’s reserves, about 12.9 million ounces, almost exactly at the 1999 bottom. The average price of gold in 1999 was $279 per ounce. Today, of course, gold is trading about $846 higher than that.

For years Doug Casey has told anyone who will listen that, in time, as the failures of the fiat system become obvious to all, central bankers would shift from sellers to buyers. Our own Bud Conrad elaborated on that point in an article in our International Speculator, circa September 2005, that I excerpt from just here…

If the central banks were to change course from being sellers to becoming buyers, the change would be dramatic. When might this happen? When the central banks see their own currencies and the reserve currencies they hold (mostly the U.S. dollar) in a persistent downtrend….

The real source of gold's rise will be the failure of the world's paper currencies at being stores of value. When currency crises force the central banks to stop their gold sales, we will know that the dollar is in serious trouble and prices of all commodities, including gold, will move much higher. Because gold has been held back, it could well jump more.

With that setup, I want to bring an article out of Bloomberg today to your attention…

Central Bank Gold Holdings Expand at Fastest Pace Since 1964

March 18 (Bloomberg) -- Central banks added the most gold to their reserves since 1964 last year amid the longest rally in bullion prices in at least nine decades, data compiled by the World Gold Council show.

Combined holdings rose 425.4 metric tons to 30,116.9 tons, an increase worth $13.3 billion at last year’s average price, according to the data. India, Russia and China said last year they added to reserves. The expansion was the first since 1988, the data from the London-based council show.

Central banks, holding about 18 percent of all gold ever mined, are expanding their holdings for the first time in a generation as investors in exchange-traded funds amass bullion as an alternative to currencies. Holdings in the SPDR Gold Trust, the biggest ETF backed by the metal, are at 1,115.5 tons, more than the holdings of Switzerland.

Read the entire article here.

Now, I don’t take this news as signs that gold is about to blast off to $2,000 overnight. But I do take it as a clear sign that big changes are in the works. With central banks increasingly unwilling to sell and willing to buy, that takes a primary source of supply off the market and puts a hard foundation under the gold market. 

And it speaks volumes about their own confidence – or lack thereof – in the fiat money experiment that is starting to spark and fizzle in most concerning ways.

While many of you, certainly those Casey subscribers of any duration, are likely well positioned in gold at this point, it’s not too late for those of you who are new to the sector. There’s no time like the present to beginning regularly buying a coin or two, and to take positions in the gold stocks that will get a lot of attention from the masses as they figure out that we’re headed for a currency crisis.

(The best Casey Research service for anyone new to the sector is, hands down, Casey’s Gold & Resource Report. At just $39 a year, your subscription will pay you back many times over.  Details here.)

Speaking of funny money, Bud Conrad has kindly sent over an analysis of the Treasury auctions that I thought you’d find useful.

Who Is Buying Treasuries?

By Bud Conrad, Chief Economist, Casey Research

The government deficit requires the U.S. Treasury to borrow around $1.5 trillion last year and this year. They have been holding big auctions that I thought would be hard to find enough buyers for. Especially since foreigners have fewer dollars to invest in our Treasuries because the trade deficit that provided them with the funds has dropped from $700 billion to $500 billion. So who is buying the government debt?

One source is our own banks. In recession, and this is no exception, banks stop making loans. To state the obvious, that’s because borrowers are less interested in borrowing and banks are more fearful of lending. The safer alternative for the banks is to buy Treasuries with whatever money they have. The chart below shows how loans decline in bad times and Treasury purchases rise.

In the current recession, banks have cut their commercial and industrial loans by about $300 billion and increased their holding of Treasuries by about the same amount. So this is one source for funding the government debt.

As mentioned a moment ago, though they have reduced their purchases, foreigners remain important to the Treasury auctions. During the recession, foreigners have shifted their preference away from buying agency debt, corporate bonds, and equities, toward safer Treasuries. The annual rate of Treasury buying from foreign sources is still running $400 billion.

Surprisingly the biggest buyer is not the big exporters of China and Japan, but England with about $200 billion (for the seven months to January, annualized). London is a financial center representing buying for others. One source is likely to be those putting on the carry trade of borrowing from the Fed at 0.1% and investing in longer-term Treasuries at, say, 2%. This could be banks, hedge funds, or hot money. The risk is low as long as the short-term rate is kept low for an extended period, so leveraging the carry trade several times over can make this a very profitable investment on the small rate differential.

A confirmation of this is that increasing portions of the auctions are accepted for direct bidders, who are not the largest 20 or so primary dealers, or the indirect bidders who are thought to be mostly foreign central banks.

Of course the Fed bought $300 billion of Treasuries in the last year, as it had announced.

I expected interest rates be forced higher to attract Treasury buyers, but rates are only up small amounts. These sources have provided the funding to keep the bidding for Treasuries high enough to prevent rates from rising much.

This situation is precarious, because the profitable carry trade is dependent on the Fed keeping rates low, and because the banks buying Treasuries only works in a situation where regular lending is risky and so the usual loans are not expanded. I think this helps explain why the Fed is keeping rates down and how the carry trade keeps longer rates contained, even with the big deficits.

If the economy really does pick up, as our leaders are hoping, so that lending starts, that would drive rates higher. My own guess is that as foreign rates move up, the dollar would weaken, bringing a need to raise rates to protect the dollar. There are many moving parts, but it seems dangerous to build big government deficits on hedge fund leveraged carry trades Treasury purchases.

On the topic of government debt, the following chart uses the latest data, from March 11, showing federal government debt growing at extraordinary levels, at the same time that the U.S. suffers its biggest-ever decline in household debt.

And You Think the USG Knows How to Waste Money…

I thought the following, out of Australia’s Herald Sun, was quite funny… and underscores just how poor decisions made without a free-market consequence can be.
 The city council has awarded Sydney artists Michaela Gleave and Kate Mitchell $5500 to build and immediately take down five 1.5m walls over five days in May.

 Gleave said they would cart 1000 bricks in a van to sites including Birrarung Marr and Federation Square, and spend from 7am to 3pm each day creating and dismantling straight walls as a comment on labour and infrastructure.

…Melbourne tradesmen said they were baffled at the decision to give two women $5500 to build walls that would last only a few hours.

Glenn Reynolds, of Chadstone firm Brick Artwork, said his young labourer could stack the bricks for about $200 per wall, taking only a few hours.

"If they're artists, they may as well draw a cartoon on a wall of a man with dollar signs flowing from his fly. Because that's what's happening," he said.

Read the full story here.

And on that note I must sign off for the day, as I am frantically preparing for a return to Argentina for a series of meetings and for the Harvest Celebration at La Estancia de Cafayate, along with many of you, dear readers.

As always, thank you very much for reading and for subscribing to a Casey Research service.

Until tomorrow…

David Galland
Managing Director
Casey Research


Mar 18, 2010