This coordination is important because their reserve tracking and auction operations are actually just a monetary tool and NOT a fiscal financing tool. When the Treasury auctions off bonds it does so only after discussing matters with the Fed’s reserve forecasters. In essence, the government is soaking up reserves that had already been spent into existence in order to target the overnight rate. It can be no other way. Without Treasury having first spent the money into existence there is no money with which the Primary Dealers can “fund” the deficit.
This doesn’t mean auctions can’t fail. They can. But quite honestly, it wouldn’t matter all that much as the reserve drain would simply take place at a later date. The auctions are designed to succeed because they are merely targeting reserves that they KNOW are in the system. There is no red phone at Treasury that Tim Geithner uses to call China before it spends money. No red phone to Japan. There is only a phone to the Fed where reserve forecasters communicate with the Treasury and the Primary Dealers to determine the size of the necessary auctions. If the Fed were to find that there were not enough reserves in the system to settle the bond auctions, as the monopoly supplier of reserves, they would make them available. Thus, when auctions are completed the reserve drain is accomplished, Congress thinks we have “funded” our spending and we can all go along our merry way.
...
It’s also important to understand that foreigners do not fund the spending of the USA. As a current account deficit nation, the US government can appropriately be thought of as a net currency exporter. This means that we send pieces of paper over the foreign nations in exchange for goods and services. In doing so these nations get the benefit of employing millions of domestic workers via their business partnerships with US corporations. But this doesn’t mean they “own” the USA. Not even close.
When China receives dollars they can only do a handful of things with these reserves. China, for the most part, chooses to invest these dollars in US Treasuries. They have attempted to use their dollars to purchase other USD denominated assets, but the US government has squashed those efforts. So, instead of leaving these pieces of paper to collect dust in vaults, they open what is the equivalent of savings account with the US government. Most importantly though, if you study the bond auction data from the USA you’ll find that indirect foreign bidders make up a very small portion of the auctions. This is due to the fact that the Primary Dealers are designed to be able to take down the entire auction. As I discussed above, this is their primary role in the agreement in being a PD. So, while China can choose to buy bonds, it is by no means necessary that they do so.
