We're Hearing Financial Crisis Talk Again

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Many of us tune out such talk; after all, there have been many such forecasts in the past. Yet the long bond-dollar anomaly suggests this time really may be different. It's certainly an issue worth another look.

There's a fair consensus that the reason for the foreign investors' reassessment is US policy changes. Start with tariffs.

The dollar had been strong when President Donald Trump was elected –“All Bow Before the Almighty US Dollar” was the headline on a DTN piece of mine last December – and it strengthened further through mid-January. The greenback began its downward trend once investors realized he was serious about big tariffs, which investors see portending slower economic growth and higher inflation.

But for the first two months of Trump's presidency, the yield on the 30-year bond was declining with the dollar. It's risen in recent weeks as it became clear that the US government's debt burden will continue to mount even with Republicans controlling the White House and Congress.

That the dollar hasn't risen with the yield suggests foreign investors aren't as willing to brush off Washington's fiscal profligacy as they were in the past. They want to be paid more for the risk of being Uncle Sam's creditors.

If that is indeed what's happening, it would be a big deal for financial markets. It's worth at least asking the big questions. Is a dollar crisis possible? Could the dollar be dethroned as the world's reserve currency?

Foreign investors will play a large role in answering these questions. They own more than $8.5 trillion of US government debt, or more than a quarter of the total. Their sales, unlike those of US investors who turn bearish on long bonds, drag the dollar down with them.

A bond-market crash isn't inevitable, to be sure. There are no signs of panic in the market. Investors are just saying it will take higher rates to tempt them to buy. When Treasuries command the desired rates, the buying will put upward pressure on the dollar.

The problem is those higher rates will also exacerbate the government's debt problem. Interest payments are already nearing $1 trillion a year and climbing. It's easy to imagine a snowball effect: As the debt burden increases, investors' concerns increase, causing them to demand still higher rates. Or they bail on US bonds, taking the dollar down with them.

Again, we're talking possibilities, not inevitabilities. But the risk of possibilities becoming realities is rising.

One thing the US still has going for it is that investors' options are limited. As long as the US dollar continues to be the world's reserve currency, foreigners will need dollars; as long as the US has the deepest capital markets, dollar assets will be an obvious parking place.