Congressional Proposals May Reduce Funding for U.S. Bond Market

The U.S. Congress, with bipartisan support, is considering legislation that could reduce the flow of funds into the U.S. bond market, cut financing for the War on Terror and support for the real estate market, increase long-term interest rates, and slow economic growth.

The purpose of this proposed legislation is to eliminate the trade deficit with China.

The U.S. Constitution gives Congress the prerogative to regulate international commerce,

About 25% of the trade deficit relates to the China trade.

(See: “Is The U.S. Trade Deficit Sustainable?“)

Funds originating from the trade deficit are a major source of financing for the U.S. bond market.

(See: “U.S. Bond Demand Has Exceeded Supply for a Decade“)

Protectionist Measures Have Bipartisan Support

Two bills, in particular, deserve attention:

  1. Senator Charles Schumer (D-NY) and Senator Lindsey Graham (R-SC) propose to impose a 27.5% import tax on Chinese goods, unless the government of China devaluates its currency against the dollar.

  2. Senator Byron Dorgan (D-ND) and Senator Lindsey Graham (R-SC) propose to strip China of its Permanent Normal Trade Relations status for having raised obstacles to imports from the United States.

These proposals are based on two assumptions:

  1. The trade deficit is necessarily bad for the United States.

  2. Increasing the cost of Chinese goods by increasing the exchange rate would make up for production cost differentials between the U.S. and China.

If the U.S. Congress is successful in ‘cracking down’ on Chinese imports, the flow of imports will probably adjust and come through other channels; the deficit will persist.

If however, Congress were to impose sufficiently strong protectionist measures to eliminate the trade deficit (e.g., high tariff barriers and direct restrictions), this would run afoul of U.S. treaty obligations with respect to the World Trade Organization. It would be a sign of the end of the era of globalization and probably the demise of the U.S. dollar as the leading currency in international trade.

If protectionist measures make any headway in Congress, a prudent investor should carefully re-consider assets allocated to long-term bonds.


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