Sunday, June 21, 2009

On Treasury Bonds and Trade Wars III

This is the third edition to my regular posting on treasury bonds and trade wars (see edition 1 here and edition 2 here).

After the US economic stimulus plan was passed with a "buy American" clause, we noted that this would trigger political retaliation from US trading partners. Last month, Canadian firms began to complain that they were losing out on US infrastructure contracts simply because they were not located in the states. We noted: "Political pressure by the Canadian business community could lead to a response by the Canadian government." Not even one month later Canadian Mayors Pass Anti-'Buy American' Resolution:

In response to the 'Buy American' provisions of the U.S. stimulus package, Canada's mayors narrowly passed a resolution Saturday that could potentially block U.S. companies from bidding on city contracts.

"Today, Canada's cities and communities joined the federal and provincial governments in a common front to try and stop American protectionism," Jean Perrault, FCM president and mayor of Sherbrooke, Que., said in a statement.

But Susan Fennell, the mayor of Brampton, Ont., stressed the resolution is not protectionism, but a message that Canadian municipalities are concerned across the country.

You can try to spin it however you want, but it is definitely protectionism. I do not blame Canada - political pressure is very high during these tough economic times for politicians to show that they are "doing something." The 575 comments to this article show the high level of importance of this issue.

Also in response to the US stimulus package "buy American" clause comes 'Buy China' Policy Set to Raise Tensions:

China has introduced an explicit “Buy Chinese” policy as part of its economic stimulus programme in a move that will amplify tensions with trade partners and increase the likelihood of protectionism around the world.

In an edict released jointly by nine government departments, Beijing said government procurement must use only Chinese products or services unless they were not available within the country or could not be bought on reasonable commercial or legal terms.


If the world economy begins to pull itself out of recession the political pressure to pass such measures will wane. If the economy only continues to slide through the end of the year, however, look for further actions from all sides as jobs continue to be lost and political pressures mount.

Next week features some very important economic developments. The Federal Reserve will meet again this week and issue its statement on Wednesday. There is no chance that interest rates will be changed this week or any time soon but there is a chance that the Fed will announce further purchases of debt instruments, such as treasury bonds. Because of the rapid rise in interest rates over the past month, we think there is a good chance that new purchasing commitments are made.

Next week also features the massive sale of $104 billion of treasury bonds. Week after week of these extraordinary levels of bond auctions leads to a greater and greater risk for a market failure. It made sense for foreign governments to subsidize American spending by buying treasury bonds when economic growth was brisk. Now that the American consumer has stopped spending, it makes more sense for foreign governments to spend their money on domestic programs to spur their own consumer spending.

These interrelated trends are continuing to evolve, or should I say devolve, at a fast pace. The longer the worldwide recession lasts the more obvious it will be that the old rules of the game will not return. In the short term, no country will win. The drop in global trade is staggering and has affected every country around the world. In the long term, those countries who are willing to bite the bullet and make the hard but necessary changes to their economic policies will be rewarded as the long term winners.
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