There is something strange happening in the world’s bond markets.
America is buying its own bonds. China has been steadily reducing its holdings of US Treasuries. Japan, the largest foreign holder of US government debt, is struggling to defend its currency without creating another problem for itself. And in the background, the BRICS countries are quietly trying to build a financial system in which they need the dollar a little less than they do today.
Most people are looking at these as separate stories.
I don’t think they are.
They are all connected.
And they tell us something important about where the global financial system is heading.
Let’s start with America
On August 19, the US Treasury announced that it would increase the size of its purchases of longer-dated Treasury bonds. The maximum purchase in each operation will rise from $2 billion to at least $4 billion from September 9. The programme is focused on bonds in the 10- to 30-year part of the market. (U.S. Department of the Treasury)
Now, $4 billion sounds like a huge number.
It isn’t.
The US Treasury market is measured in tens of trillions of dollars. So this isn’t going to magically solve America’s debt problem. But that is missing the point. The important thing is why Washington felt the need to do it now.
The 30-year US Treasury yield recently went above 5.3%, its highest level since 2007. (Reuters)
That is beginning to hurt.
It hurts the government because it has to pay more to borrow. It hurts companies because borrowing becomes more expensive. It hurts the housing market. It hurts equities because investors start asking why they should take equity risk when government bonds are offering much higher returns. And it hurts the government budget again because higher interest payments mean an even larger deficit.
That is the uncomfortable part.
America already has a huge amount of debt. Now the cost of servicing that debt is becoming a bigger problem.
But there is something else going on
For a very long time, America had an extraordinary advantage. The rest of the world wanted dollars. And when the rest of the world accumulated dollars, much of that money found its way back into US government bonds.
- China bought them.
- Japan bought them.
- Other central banks bought them.
- Pension funds bought them.
- Insurance companies bought them.
The US could borrow enormous sums because there was always a large pool of buyers. That arrangement made America’s debt problem look much smaller than it really was. The world was happy to finance America.
The question now is:
Will the world continue to finance America at the same price?
That is a very different question.
China has already started answering it
China is not suddenly dumping Treasuries. That story is too simplistic. China is doing something much more sensible. It is slowly reducing its dependence on them.
China’s Treasury holdings once exceeded $1.3 trillion. By June this year, reported holdings had fallen to around $633 billion.
That is a remarkable change.
But I don’t think Beijing wants to crash the Treasury market.
Why would it?
China still owns hundreds of billions of dollars of US government debt. If it dumped everything tomorrow, it would hurt itself. Treasury prices would fall. Yields would rise. The dollar could weaken. The renminbi could strengthen. Chinese exports would suffer. And the value of the Treasuries China continues to hold would fall.
China isn’t stupid.
It knows exactly where the line is.
So it is doing something much more interesting.
It is slowly moving away.
Why?
Because China has learnt a lesson from Russia. After Russian reserves were frozen following the invasion of Ukraine, every major central bank had to ask itself a question:
What exactly does it mean to own a reserve asset if somebody else controls the financial system through which you access it?
China took note.
Gold cannot be frozen in quite the same way. Local currencies cannot be sanctioned in the same way. Alternative payment systems cannot be switched off by Washington in the same way.
So China has been building alternatives.
- More gold.
- More RMB settlement.
- More use of its own payment infrastructure.
- More bilateral currency arrangements.
- Less dependence on US Treasuries.
This isn’t an anti-dollar revolution. It is insurance.
China is effectively saying:
I will continue to use the dollar because it is useful. But I don’t want to be dependent on it.
That is a very important distinction.
Japan is a completely different story
China is trying to get out.
Japan is trying to survive inside the system.
Japan owns roughly $1.1 trillion of US Treasuries and remains the largest foreign holder.
Why did Japan accumulate so much?
Because Japan spent decades with almost no interest rates. Japanese investors had very little reason to keep their money at home. So they went abroad. The US became one of the biggest destinations. And that created a huge pool of Japanese money invested in US assets.
But now Japan has a problem.
The yen has become very weak. And a weak yen isn’t quite as wonderful as it sounds.
- Japan imports energy.
- It imports food.
- It imports raw materials.
When the yen falls, all of these become more expensive. So what was once a benefit for Japanese exporters has become a problem for Japanese households. Inflation has become politically uncomfortable. And Japan has been forced to defend the yen.
And this is where America gets involved
Normally, you would say:
“That’s Japan’s problem.”
It isn’t.
Not anymore.
Because Japan owns more than a trillion dollars of US government bonds. If Japan needs dollars to defend the yen, it could sell some of those bonds. And if Japan sells a lot of Treasuries at the same time, what happens?
There are more bonds in the market. Bond prices fall. Yields rise. And suddenly America’s borrowing costs go up.
So the US has a very direct interest in keeping Japan’s currency problem under control.
This is why the recent coordination between the US and Japan over the yen is so interesting. It isn’t simply an act of friendship between two allies. It is also financial self-interest. America doesn’t want Japan to solve its currency problem by destabilising the Treasury market.
Japan has another problem nobody can wish away
Japan’s government debt is enormous. More than 200% of GDP. For years, that wasn’t as frightening as it sounds because Japan could borrow at extraordinarily low interest rates.
That world is changing.
Japanese government bond yields have risen sharply, with the 10-year yield approaching levels not seen since the 1990s.
Now Japan has a terrible choice.
- Raise interest rates and support the yen. But higher rates make Japan’s enormous debt more expensive to service.
- Keep rates low. Then the yen remains vulnerable.
- Sell US assets. That gives Japan dollars with which to defend the yen, but puts pressure on US bonds.
- Bring money back home. That supports the yen, but reduces Japanese demand for US Treasuries.
There is no perfect solution.
And this is why Japan matters so much to the US Treasury market. Japan doesn’t have to sell its entire $1 trillion portfolio. It only has to become a smaller buyer.
That alone changes the equation.
And then there is FIMA
This is perhaps the most interesting part of the whole story.
The Federal Reserve has a facility called FIMA.
The name isn’t important.
The idea is.
A foreign central bank such as Japan can effectively use its US Treasury holdings as collateral to borrow dollars rather than immediately selling those Treasuries.
In simple terms:
Japan needs dollars. Instead of selling its bonds to get the dollars, it can temporarily borrow against them.
The bonds don’t flood the market.
That is important because it prevents a currency intervention from automatically becoming a Treasury-selling exercise.
Think of FIMA as a pressure-release valve.
It buys Japan time.
But it doesn’t solve Japan’s underlying problem. If the yen remains weak for years, you cannot keep borrowing dollars forever and pretend nothing has happened. Eventually the underlying problem has to be dealt with.
Now step back for a moment
Look at what is happening.
America is worried about the cost of its debt. China is reducing its dependence on that debt. Japan is struggling with its currency and its own enormous debt burden. And both China and Japan are among the biggest foreign holders of US Treasuries.
That is not a coincidence.
It is the changing architecture of the global financial system showing itself through the bond market.
The politics between the three countries is fascinating
America wants China to keep participating in the dollar system. China wants to reduce its dependence on America. America needs Japan. Japan needs America.
China competes with America. Japan is America’s strategic ally. Japan also happens to be one of America’s largest creditors.
So the relationships are no longer simply political.
They are financial.
Washington can pressure Tokyo. But Washington cannot afford to push Tokyo too far. China can reduce Treasury purchases. But China cannot afford to destroy the value of the assets it still owns. Japan can sell Treasuries. But doing so could hurt the very market in which Japan has invested so much.
Everybody is trapped to some degree.
This is the part I find most interesting
America’s biggest problem isn’t China selling $20 billion. It isn’t Japan selling $50 billion. It isn’t even BRICS creating a new currency.
The real problem is much quieter.
What happens if the world’s big reserve managers simply decide:
“I don’t need to own as many US Treasuries as I used to.”
That’s it.
No dramatic announcement. No financial crisis. No declaration of war on the dollar.
Just less buying.
That is enough.
Because America needs to refinance enormous amounts of debt every year. If the traditional buyers become less enthusiastic, America has to find other buyers. And those buyers will ask for something in return.
A higher yield.
This is where the Treasury buyback comes in
The Treasury’s new buyback programme is small compared with the size of America’s debt market. It won’t fix America’s finances. It won’t stop China diversifying. It won’t solve Japan’s problems.
But it does something very important.
It tells the market:
Washington is paying attention to what is happening at the long end of the bond market.
And the market noticed.
US bond yields fell sharply immediately after the announcement, although much of that relief subsequently faded. (Reuters)
That is why I see this less as a solution and more as a warning. America is beginning to discover that the cost of borrowing matters.
And when you have more than $40 trillion of debt, even a small change in the cost of borrowing eventually becomes a very large number.
Now bring BRICS into the picture
This is where the discussion often becomes unnecessarily dramatic.
Every few months we hear:
“BRICS is going to launch a currency that will destroy the dollar.”
I don’t buy that.
A common currency is extraordinarily difficult. Look at Europe. It took decades to create the euro. BRICS countries have completely different economies, political systems and interests.
China wants the RMB to become more important. India isn’t going to happily hand China monetary dominance. Russia wants protection from the dollar system. Brazil wants to maintain its own monetary independence.
There isn’t enough common ground for a genuine BRICS euro. At least not anytime soon.
But that doesn’t mean nothing is happening.
Quite the opposite.
The real BRICS story is payments
You don’t need a new currency to reduce the dollar’s importance. You simply need to conduct more business without the dollar.
That is much easier.
If India buys something from China, they don’t necessarily have to settle the transaction in dollars. If Russia sells oil to India, they don’t necessarily need the dollar in the middle. If China trades with Brazil, the same principle applies.
- Build payment links.
- Build currency arrangements.
- Build settlement systems.
- Use local currencies.
And slowly, the dollar becomes less necessary.
That is much more realistic than suddenly replacing it.
And that is where the real danger for America lies
Not that the dollar disappears.
It won’t.
The US has the deepest capital markets in the world. It has an enormous financial ecosystem. It has the Treasury market. It has global banks. It has decades of trust and habit behind the dollar.
These things don’t disappear overnight.
But the dollar doesn’t have to disappear for America to have a problem. It only has to become less indispensable.
That is a much more realistic possibility.
Imagine this happening over ten years
China gradually reduces its Treasury holdings. Japan brings more money home because Japanese interest rates become more attractive. Other central banks buy more gold. BRICS countries settle more trade in their own currencies. More payment systems operate outside the traditional dollar network.
The dollar remains the world’s largest reserve currency. But its share gradually falls.
What happens then?
America has fewer automatic buyers for its debt. And when the automatic buyer disappears, the price becomes more important. That means America may have to pay more to borrow.
And this is where the problem becomes circular
Higher borrowing costs mean higher interest payments. Higher interest payments mean a larger deficit. A larger deficit means more borrowing. More borrowing means more bonds. More bonds require more buyers. And if there are fewer buyers, the price has to adjust.
The price adjustment happens through higher yields.
That is the part that should worry Washington.
Not a sudden collapse.
A slow increase in the price America has to pay for its fiscal excesses.
I don’t think the dollar is going away
In fact, I think the dollar will remain dominant for a very long time. But I also think something important is changing.
For decades, America enjoyed something close to a monopoly in global finance. The world needed dollars. The world needed Treasuries. The world needed US financial markets. That gave America enormous freedom.
That freedom is slowly being challenged.
Not by one country.
Not by one currency.
But by a combination of small decisions being made by many countries.
- China buying a little less.
- Japan investing a little more at home.
- Central banks buying a little more gold.
- India settling a little more trade in rupees.
- China settling a little more trade in yuan.
- BRICS building a little more payment infrastructure.
Each decision looks insignificant.
Together, they are not.
The biggest mistake would be to look for a single event
There won’t necessarily be a day when somebody rings a bell and announces:
“The dollar era is over.”
It doesn’t work that way.
Reserve currencies don’t usually disappear overnight.
They lose ground slowly.
- First in trade.
- Then in payments.
- Then in reserves.
- Then in investment decisions.
And eventually, the market starts charging the issuer differently.
That is the point I would watch.
Not whether the dollar is still number one. But whether America is still able to borrow as cheaply as it once did.
And this brings us back to the Treasury buyback
The buyback itself is not the story. China isn’t the story. Japan isn’t the story. FIMA isn’t even the story.
They are all symptoms.
The story is that the world which automatically recycled its savings into US government debt is changing. America is still the most powerful financial market in the world. But the rest of the world has discovered that it has choices.
China is exercising those choices. Japan is being forced to reconsider them. India and other emerging economies are exploring them. BRICS is trying to make them easier.
And America is beginning to respond.
That is why I find the latest Treasury move so interesting.
It isn’t a crisis.
It isn’t QE.
It isn’t the beginning of the end of the dollar.
It is something much more subtle.
America is beginning to manage a world in which its creditors have more choices than they used to. And when your creditors have choices, the price of borrowing becomes a very different conversation.
The next decade may therefore not be about the death of the dollar. It may be about something more important:
The end of America’s ability to assume that the world will finance its deficits on whatever terms America wants.
That, to me, is the real story behind the Treasury buyback.
And it is a story that has only just begun.
