Foreign Buying of National Debt: A Seismic Shift in Investor Psychology

By Dr. Mark Skousen, Investment U Advisory Panelist
Friday, September 23, 2005: Issue #471

“There are disturbing trends: huge imbalances, disequilibria, risks Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot.” – Paul Volker, former Fed chairman, 2005

Last week, a major paradigm shift occurred in the world, a financial event as dramatic as Hurricane Katrina. The signposts are:

• Foreign countries have dramatically cut back on buying U.S. Treasuries.
• The Federal deficit is expected to balloon to more than $500 billion in fiscal 2005.
• While Wall Street floundered again, gold hit a 17-year high of $470 an ounce, and is likely to exceed $500 an ounce by the end of the year.

Every 20 years or so, there’s a financial revolution: 1960-80 was an era of rising inflation and instability, where the watchwords were “buy gold, buy silver, buy Swiss francs.” Then, just as investors were giving up on Wall Street, Thatcher and Reagan were elected and for the next 20 years (1980-2000) and we witnessed a dramatic age of technological growth, global liberalization, and disinflation all ideal conditions for a massive rally in stocks and bonds.

Now another financial revolution is in the air. It appears that the next 20 years will be a period of global destabilization and massive re-inflation.

Now here’s what we can do about it…

Our Creditors Are Re-Balancing Their Portfolios By Buying Metals

Investors must arrange their financial strategies to survive and prosper during this paradigm shift. The fact that gold – the best indicator of global instability – has been rising steadily in price since 2001 should be a wake-up call.

In my last Investment U column (Powerful Financial Planning Tools), I noted that Americans are failing to save enough and are vulnerable to financial stress. They have been bailed out by foreign buying of our stocks, bonds, and real estate… at the tune of $4 billion a day. China, in particular, has been a major buyer of Treasury debt.

As a result, the United States continues to enjoy very low interest rates. In fact, interest rates are still negative in real terms. With the consumer price index (CPI) rising at a 5% rate for August, 10-year Treasuries at 4.25% are below inflation.

But there is danger ahead. For the past several years, foreigners have been buying 70% or more of our national government debt. However, those purchases have started to decline precipitously, from a peak annual rate of $400 billion in early 2004 to about $200 billion in 2005 and, in the most recent quarter, to only $100 billion.

Take a look at the slowdown in the purchase of Treasuries in the chart below (note the dark blue line)…

The sharp slowdown in foreign purchases of Treasuries means two things:

• Foreign central banks from China to Argentina are quietly shifting to non-paper assets, specifically gold and precious metals, to diversify their portfolio.
• The U.S. Treasury will be forced to raise interest rates to keep foreigners from unloading their T-bonds.

Here Are Two Strategies To Consider:

1. Increase your precious metals holdings: buy gold and silver coins, mining stocks, and especially silver and palladium stocks. (Palladium is the cheapest of all the precious metals; it has fallen 80% in value since 2000! But it is now staging a comeback.)

2. Take profits on your income investments: Reduce your holdings of Treasury securities, municipal bonds and municipal bond funds, and other interest-sensitive positions. One exception might be Inflation-Indexed Treasuries (TIPS) – they should maintain their value during the next few years as inflation heats up.

Good trading,

Mark

• Treasury TIPS Coming Back into Fashion
• Citigroup Gets Treasury “Seal of Approval”
• China’s Investment Alternatives: Why China Can’t Sell U.S. Treasuries

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