Article - China's Declining US Treasury Purchases:

China's focus on exports has been a great pillar of support for the USD due to the "Dollar Sterilization" policy of buying US Treasuries to keep the USD/Renminbi exchange within a tight trading range. The policy was meant to keep Chinese goods inexpensive for export by taking the trade surplus dollars meant as payment to Chinese suppliers (which would normally have been converted from USD  to Renminbi) and re-investing them directly into US Treasuries to prevent the Renminbi from appreciating. Of course China still had to pay the Chinese suppliers which it did by printing more Renminbi.

Now this pillar is wavering and Chinese exports to the USA are decreasing dramatically as:

• Wages in China are increasing due to the delayed inflationary effects of the large amounts of Renminbi that have been printed over the last years to keep the Renminbi from appreciating vs. the USD (see Dollar Sterilization). Thus Chinese products are becoming more expensive in both Renminbi and USD terms regardless of currency pegs.
  
   
• The high US unemployment, high personal debt and foreclosures are causing less and less consumer demand for Chinese products in the US.

The net effect is that China is now shifting focus from supporting exports to stimulating local Chinese demand and implementing massive construction and modernization projects as detailed in the latest 5 year economic plan.

As the USA becomes less important for China's economic plans and the value of the USD more suspect the Chinese Central Bank has decreased the purchase of US treasuries considerably. The Chinese are eager to invest in their own country and are diversifying into other foreign Bonds (see the recent large Spanish debt purchases) and of course physical Gold / Silver.

In a free market the reduced demand for US bonds by the Chinese should increase interest rates in the USA, however the Federal Reserve has been replacing the Chinese purchases through their "Quantitative Easing" policy of buying US bonds by, essentially, creating new currency out of thin air to purchase their own governmental debts.

The scale of the FED's Quantitative Easing program has been so large that the Federal Reserve now owns more Treasury debt than China. Yet China paid for their share of US treasury debt by selling countless real goods to the USA whereas the Federal Reserve has simply created the currency at the stroke of a button and by the will of the Federal Reserve.

In this context let's remember that a US Dollar is nothing more than a debt backed by an ethereal concept titled the "Full faith and credit of the United States". As the US enthusiastically creates massive new debts (see CBO projects U.S. budget deficit to reach $1.5 trillion in 2011, highest ever) and as the FED issues currency to buy these debts the purchasing power of each USD note will likely fall at a faster and faster rate. 

Thus USD creditors and investors are bound to see their debt repaid in debased dollars whose purchasing power will have fallen drastically due to, in large part, to the Fed's policies of easy money. if you have a US income you have experienced this yourself as the USD has fallen over 15% in the last two years vs. the SGD and most other currencies. Thus it is no wonder that the Chinese are shying away from the US Treasuries; it is just a matter of doing so gradually without creating too many headlines.

65 years ago the USD was still considered "as good as gold" as the currency was [theoretically] backed by Gold and Silver (see Silver Certificates / Notes). This partial backing slowed the issuance of new currency and debt to some degree. When Secretary of the Treasury C. Douglas Dillon halted redemption of Silver Certificates in March 1964 and when president Nixon abandoned the gold standard in 1971 (caused largely by the French who realized that the US had over-issued currency and demanded conversion of their USD to Gold at the official 35 USD per oz ratio) it set the stage for today's seemingly limitless explosion of debt and blatant devaluation of the worlds reserve currency.

Today, 40 years after abandoning the gold standard, the USD is increasingly becoming a hollowed out currency. The world's largest creditor nations are becoming ever more reluctant to buy US debt and as the US economy becomes less important as an export market this trend is only set to accelerate and feed on itself. The Fed's Quantitative Easing policies only help to fuel this mistrust as they finance debts levels never seen in the history of a currency. 

To summarize:

The US is in serious financial trouble. The situation is becoming worse with every new record deficit and QE round as policy makers are focused solely on optimizing a few immediate economic factors instead of the long term well being of the country. Eventually major commodities such as oil will no longer be priced in USD. When this occurs the most important pillar of USD support will be removed and the USD, as we know it, will be finished.

Holders of USD will lose their purchasing power at an accelerating rate and precious metals owners will be, and have been, the direct beneficiaries as more and more investors will seek to exchange their paper IOUs to physical, non-debasable, Gold and Silver.

Article by: Gregor J. Gregersen