Reuters reports:

Federal Reserve purchases of U.S. Treasuries have not produced a lasting drop in long-term yields, according to a study by the St Louis Federal Reserve…

The Fed shocked markets on March 18 with a $300 billion purchase program of longer dated U.S. Treasury bonds, which quickly reduced longer bond yields by about 50 basis points.

Here’s the funny part:

“The marked flattening of the yield curve associated with the (Fed’s) announcement has vanished. Instead, the yield curve has become more steeply sloped,” the study noted. It said it was not possible to single out what was driving up yields.

Duh, yields are going up because the purchasing power of the dollar is expected to fall with the FED’s announced monetization, er “quantitative easing”. But it’s not possible for the St. Louis FED to figure this out…

China has certainly figured it out.  They are staying in the short end of the yield curve… From China Daily:

Shen Minggao, chief economist with the business and financial magazine Caijing:

I doubt the US government’s ability to ensure the safety of China’s investment in Treasuries. At least for the present, Washington has nothing to assure us on.

What the US government can guarantee is avoiding credit risk – it will not default on its debt. But that cannot provide any shelter for investors to avoid inflation, the depreciation of the dollar or risks in liquidity. These pose major threats to China’s holdings of Treasuries with maturities longer than a year.

Bloomberg reports that RBC is calling China’s stockpiling of commodities its “new sovereign wealth strategy”:

“It’s part of an overall desire to decrease its exposure to dollar assets,” said Brian Jackson, senior strategist at Royal Bank of Canada in Hong Kong, in an interview today. China fears the hundreds of billions of dollars the U.S. is spending on bank bailouts and stimulus will cause “higher inflation and a weaker dollar,” he said.

“Increased spending on commodities represents a reallocation of China’s sovereign wealth away from the accumulation of financial assets,” Jackson said in a May 15 research note.

China, the world’s biggest consumer of iron ore, boosted imports of the material to a record 57 million metric tons in April. China’s purchases of copper and copper products reached a record 399,833 metric tons last month, compared with 374,957 tons in March.

…China, the world’s second-biggest energy-consuming country, increased crude imports by 14 percent in April.

As the FED engages in at least $300B of QE (probably much more before they are through), it’s buying Treasuries from the market that China can sell into the market (or at least not buy) without prices changing substantially.  The big fact in this article is this:

Without this stockpiling of strategic commodities, China’s trade balance likely would have risen in the first quarter instead of falling $51.8 billion to $62.51 billion…

That’s $50 or $60B per quarter of commodity stockpiling…in another 4 or 5 quarters, China will have up to $300B in commodity reserves… So what else are the Chinese buying?   Ambrose Evans-Pritchard reports:

“There is a significant shift taking place in China. They are concerned about the stability of the global financial system so they are not going to sell US bonds they already have. But they are still accumulating $40bn of fresh reserves each month, and they are going to be much more careful where they invest it,” he said.

Hans Redeker, head of currencies at BNP Paribas, said China is switching into hard assets. “They want to buy production rights to raw materials and gain access to resources such as oil, water, and metals. They know they can’t keep buying bonds,” he said

So…in addition to stockpiling commodities, China is scarfing up real assets that produce these commodities: coal, copper, iron and gold mines, oil fields, timber lands… In another 4 or 5 quarters they will have as much in hard assets as they have in dollar denominated financial assets.  Then, if the dollar falls in value by (say) 50%, their hard assets will rise by a like amount, leaving them insulated from the dollar’s decline.  Will the decline wait for China to get into position…or does China control this timing?

John Hussman makes two excellent points…whether you are a bull or a bear, you have to accept the cold facts and see the forest as well as the trees:

1. “So where does the money come from to buy [all] these new Treasury securities? Clearly, the sale of those securities must absorb the savings of someone in the economy whose savings have not already been claimed. Alternatively, the Fed can directly purchase those Treasury securities and literally print money. In practice, we have a third option. The Fed can acquire $1 trillion of commercial mortgage-backed securities and other assets from banks and create an equivalent amount of “reserves” (which is essentially printing money) at the same time that the Treasury issues the $1 trillion in new Treasury securities. In this case, which is in fact exactly what has happened, the banks that previously held $1 trillion in commercial debt securities can now use their newly acquired reserves to buy the $1 trillion in newly issued Treasuries. Having done this, they have no more money to lend than they had before. There is no more “liquidity” in the system than there was previously, except that the “quality” of the bank balance sheets has improved.”

2. “It is an error to view outstanding debt securities as if they are “liquidity” poised to “flow back into the stock market.” The faith in that myth may very well spur some speculation in stocks, but it is a belief that is utterly detached from reality. The mountain of outstanding money market securities is the result of government debt issuance that must be held by somebody until those securities are retired. It is not spendable “liquidity” – it is a pile of IOUs printed up as evidence of money that has already been squandered.”

Zero Hedge ran a post this weekend revisiting Friedrich Hayek’s seminal Prices and Production,  in which the professor recognized that when total debt outstanding rises, whether through conventional banking or shadow banking, that increased credit has been used to bid up consumer goods and investment asset prices:

“There can be no doubt that besides the regular types of the circulating medium, such as coin, notes and bank deposits, which are generally recognised to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money. Now while for certain practical purposes we are accustomed to distinguish these forms of media of exchange from money proper as being mere substitutes for money, it is clear that, other things equal, any increase or decrease of these money substitutes will have exactly the same effects as an increase or decrease of the quantity of money proper, and should therefore, for the purposes of theoretical analysis, be counted as money.

…but once they have come into existence their convertibility into other forms of money must be possible if a collapse of credit is to be avoided.”

In point 2, above, Hussman is emphasizing this point:  when debt is created, it is simultaneously “attached” to some consumer good or investment asset, it is not sitting “idle” on the sidelines in liquid form…waiting to be attached to (say) stocks.  To be attached to stocks, bonds, consumer goods or whatever it was previously attached to, must be sold down first.   In point 1, above Hussman, is emphasizing that the recent FED activities has provided no new credit to the banks…only the opportuntity to “swap” a toxic asset for a US Treasury security.  Currently,  if the banks decide to sell the Treasuries to raise cash to lend or to invest in stocks (like Goldman)…the price of Treasuries goes down and the yields go up.  If yields go up, the “recovery” is jeopardized.