The public didn't pay much attention to this comment by Congressman Mark Kirk last week, but they should have.
"It would appear, quietly and with deference and politeness, that China has canceled America's credit card," Kirk told the Committee of 100, a Chinese-American group.
"I'm not sure too many people on Capitol Hill realize that this is now happening," he said.
It's hard to believe when you consider that China has bought over $1 Trillion of our debt, and the largest single-year purchase was 2008.
But now it appears that Mark Kirk knew what he was talking about.
"There will come a time where the lack of Chinese participation may have a significant impact," Kirk said.
"We should track that, because up until last month they were the number one provider of currency to the United States and now they're gone."
The time for that impact is starting already. Recent treasury bond auctions have not gone well.
U.S. debt prices slid, sending the 30-year Treasury bond yield to its highest since November.
"The auction is big news because now it's showing that maybe the Chinese don't want our bonds. If the cost of capital for the United States becomes more expensive, then the recession is going to take that much longer to get out of," said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey.
The old saw of the dollar bulls is "where else will China puts its dollars?" It's sort of like Walmart deciding that it doesn't have to have low prices or quality control because "where else will the customers go?"
It appears that dollar bulls are about to discover the answer to that question that they thought there was no answer to.
For starters, China is buying
More than anything, China has been on a worldwide buying spree this year. But instead of buying our debt, they've been buying up natural resources.
The deals have allowed China to lock up supplies of oil, minerals, metals and other strategic natural resources it needs to continue to fuel its growth. The sheer scope of the agreements marks a shift in global finance, roiling energy markets and feeding worries about the future availability and prices of those commodities in other countries that compete for them, including the United States.
They've also spent $586 Billion on themselves, stimulating their own economy rather than ours.
Adding to that, China has been making currency swap agreements with nations around the world. That means that they will be able to trade with foreign nations in their own currency, and not have to use dollars.
These currency swap agreements happened just days after the Federal Reserve announced that it would be purchasing $1 Trillion in treasuries and agency debt. Of course since the Federal Reserve produces nothing except for paper money, those purchases would be created by creating money out of thin air.
The law of supply and demand is clear - if you dramatically increase the amount of currency in a system without increasing the amount of goods, then the currency is worth less. The Chinese are very familiar with this law, and so they immediately started to make moves away from the dollar. No sense throwing good money after bad.
So "what will China do with all that money?" Plenty. They aren't a captive of our economy after all.
As a region, Asia has created a $120 Billion Asian Monetary Fund - directly undermining the IMF, which has the same mandate. America holds veto power in the IMF, but no power in this new international body. Lawrence Summers and Timothy Geithner opposed this idea as part of the Clinton administration, which shows how much power America has lost during the past decade.
It takes a very long time to change the direction of a market as large as the treasury market. Even the Federal Reserve, with its unlimited printing presses, can only move it slowly.
A deflating bubble
“Confidence in the U.S. dollar is ‘fraying’ and a shift away from the greenback after the financial crisis is inevitable."
- Nobel Prize-winning economist Joseph Stiglitz
At the start of the year I said that the treasury market was a bubble that had to burst. There was no justification for such low yields.
Those who sold their treasuries at that time would have saved themselves from very significant losses.
Since then private foreign investors have consistently been net sellers of our debt. Even central bank buying hasn't been enough to offset it.
There's no secret why that has happened - we've been selling them bad debt.
Without the foreign creditors, and without any real domestic savings, we have no choice to fund our federal borrowing by turning to the federal reserve's printing press.
This also has consequences.
(Reuters) - China and other emerging nations back Russia's call for a discussion on how to replace the dollar as the world's primary reserve currency, a senior Russian government source said on Thursday. Russia has proposed the creation of a new reserve currency, to be issued by international financial institutions, among other measures in the text of its proposals to the April G20 summit published last Monday.
Calls for a rethink of the dollar's status as world's sole benchmark currency come amid concerns about its long-term value as the U.S. Federal Reserve moved to pump more than a trillion dollars of new cash into the ailing economy late Wednesday.
"Foreign Central banks aren't going to finance much of the 2009 US fiscal deficit; Their reserves aren't growing anymore."
- Brad Setser, Council on Foreign Relations