After months of warnings, China has dumped tens of billions of its huge U.S. debt holdings and now Japan — the other major U.S. creditor abroad — could follow suit, warn top Japanese bankers.
The implication for interest rates and for the value of the U.S. dollar has investors buzzing about gold and other hedges against a falling greenback.
It also creates serious concern for the nascent U.S. recovery. Quickly rising interest rates could slam the brakes on the recent GDP rebound.
Treasury said this week that foreign holdings of U.S. Treasury bills slipped by $53 billion in December, far more than the previous record drop of $44.5 billion in April 2009.
China alone dumped $34.2 billion of its U.S. debt, falling to $755.4 billion and, a result, pushing Japan into the No. 1 position among U.S. foreign creditors.
"Fears are growing that the U.S. fiscal health will worsen further as (President Barack) Obama hasn't been able to offer details on how to rebuild government finances," Akihiro Nishida, senior fixed income strategist at Mitsubishi UFJ Securities, told The New York Times.
"Many now expect the U.S. government won't cut public spending or raise taxes ahead of November's midterm elections."
Japanese bankers also worry that bond yields will rise as the Fed tightens, causing bond prices to drop.
Obama predicted in early February that the deficit would rise to $1.56 trillion and stay above $1 trillion for three years. Obama forecasted that the 2011 deficit would be $1.27 trillion.
The 10-year Treasury yield is now 3.74 percent, while the 30-year bond is at 4.71 percent.
Meanwhile, billionaire investor George Soros doubled his stake in a gold fund, essentially a contrarian bet on the direction of the dollar. His hedge fund, Soros Fund Management, now owns 6.2 million shares of the SPDR Gold Trust (GLD), up from 2.5 million before.
His peer John Paulson, the hedge fund guru who managed to short the housing market before it crashed — making his name and earning billions in the process — also recently upped his take in the metal. Both men have been buying financial stocks as well.
The clock could be ticking down for Fed Chairman Ben Bernanke’s long-held pledge to keep interest rates low for “an extended period.”
Member of his own board recently warned that the swelling U.S. debt balloon meant that the Fed might lose control of rates before long.
"The current outlook for fiscal policy poses a threat to the Federal Reserve's ability to achieve its dual objectives of price stability and maximum sustainable long-term growth, and therefore is a threat to its independence as well," Kansas City Federal Reserve President Thomas Hoenig said in a speech this week.
Despite the ominous signs, Treasury chief Tim Geithner dismissed warnings from Moody's Investors Service that the United States could lose its top credit rating if the government doesn’t begin to cut spending.
Geithner said earlier this month that the United States "will never" lose its credit rating and predicted that foreigners would stick with U.S. debt.
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