Why are stocks rising despite bad news?

Regarding China's holdings in U.S. Treasury debt: Is it possible for China to call in all the debt at once? If so, what would the impact be to the U.S. government and the U.S. economy in general?  
— M.C., Stafford, Va.

Debt securities (bonds, bills and notes) sold by the U.S. Treasury are not “callable.” That means investors can’t ask for their money back before the security matures. The maturity date, anywhere from 3 months to 30 years, is set when the debt is auctioned off to investors.

But investors who want to unload their Treasuries can do so in a very active “secondary” market, where $1 trillion worth of outstanding debt is traded every day. China holds about $500 billion in Treasury securities.

So, as big as the market is, if China sold all its U.S. debt at once, the market would have a hard time absorbing it. Bond prices would likely fall and interest rates would soar. Such a vote of no confidence could also send the dollar falling further.

That, of course, is why China would never do such a thing. It would be virtually impossible to liquidate half a trillion in U.S. Treasuries at once — even if you could find buyers — without destroying the value of your own holdings. China also wants to keep its currency from getting too strong against the dollar; dumping its U.S. debt holdings all at once would hammer the dollar and make Chinese exports much more expensive to American buyers. So cashing out of Treasury debt in hurry would be financial suicide.

The more realistic concern is that China — and other large buyers of our debt — slow or stop their purchases. Demand for Treasuries keeps long-term interest rates under control. If that demand goes away, Uncle Sam has to raise rates to find fresh buyers.

The Fed, which controls short-term rates, has much less control over market-based long rates. The only thing it could do is drain money out of the system — which is exactly what you don’t want to do in a credit crunch (See: "Depression, Great.")

The solution, of course, is to balance the federal budget. But cutting spending and/or raising taxes is not a great idea when the economy is weak. Even if the world's appetite for U.S. debt remains strong, it’s long past time for Congress and the White House to get our financial house in order.

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