Treasury bonds are risky bet

The US Senate and House agreed on a $787 billion stimulus package to save the economy. The total US government debt, including bills, notes, and bonds and an estimated US federal budget deficit of $1.2 trillion, will amount to $2 trillion.

Some analysts believe scared global investors will shift to US treasury bonds, which are considered the "safest" securities, and certainly money has flowed into US treasury bonds since the financial tsunami broke out.

But the potential risks of treasury bonds are also accumulating.

If no other country's central banks are willing to increase their holdings of US treasury bonds, and no international investor will buy them, exactly how the US government will finance its colossal economic stimulus plan is unclear.

The US Federal Reserve will inevitably act as the ultimate financier to bolster the economy. Under such an unconventional circumstance the Federal Reserve will likely to keep its nominal short-term interest rate at around zero. It has also pledged to expand its balance sheet to finance the government's new stimulus plans. Once the US government starts implementing detailed stimulus measures, the Federal Reserve's balance sheet is expected to further expand to $3 trillion.

The rapidly expanding national debt of the US will affect credit rating for US treasury bonds. US treasury bonds may become hard pressed to keep their AAA rating. The 10-year US treasury bond yield was an average 2.30 percent in January, the lowest on record.

US treasury bonds are supported by the nation's credit but US national credit has been tainted in the financial crisis. In the short term, however, the US government can't break away from the current borrowing-bailout-more borrowing cycle.

The US Treasury bond bubble is ballooning and is set to burst. Global investors are keeping a close eye on the mounting risks, but few expect the bubble to explode soon. They are waiting for the best time to dump the bonds. Many of them, however, think that it will be too late to leave the game when China and Japan decide to stop buying or begin selling the US Treasury bonds.

China's financial security is banded tightly with US Treasury bonds, which are fast becoming a risky option.

The author is an analyst with the Anbound Group, a Beijing-based consulting firm. The article is reprinted from China Business News

(China Daily 02/23/2009 page2)