China Decoupling And The Trade Of The Century In The Bond Market

Some argue that this financial crisis will lead to China “decoupling” from the US economy; meaning it will need to find other buyers of its exports, and will not be able to continue buying US Treasury bonds, which have the affect of propping up the US dollar’s value. Instead, the decouplers argue, China will need to invest in increasing its own consumption capabilities. This will have the effect of decreased buying in the Treasury bond market while the supply of Treasuries expands as US government deficit increases — thus making short selling long-term Treasuries one a very lucrative opportunity, if this is in fact the case.

Can this happen? If so, when?

Skeptics of decoupling argue that the decline of US demand will weaken the Chinese economy along with the US economy, and that the current structure of US consumption driving the global economy will maintain. Decouplers note that the Chinese economy will weaken, but this will force the Chinese government to invest in more infrastructure programs instead of buying Treasury bonds — at a time when the US is planning to take on more debt and thus increase the supply of Treasury bonds. The result of this will be currency decoupling in that China will become an increasingly powerful buyer relative to the US. And from a geopolitical perspective, China is more economically aligned with Pakistan, Iran, Russia, and Hamas rather than the US/Israel/Britain economy. Thus far, we have seen China direct its buying towards domestic stimulus packages.

With that said, though, Treasury buying could go on for a while; Naked Capitalism notes that China is still buying Treasury bonds. For those who think decoupling is bound to happen, the opportunity to short Treasuries may be the best trade out there when the bubble starts deflating, whenever that may be. TBT is the double inverse ETF for the long-term Treasury bond market.

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