History
The U.S. government knew that the costs of World War I would be great, and the question of how to pay for the war was a matter of intense debate. The resulting decision was to pay for the war with a balance between higher taxes (see the War Tax Act) and government debt. Traditionally, the government borrowed from other countries, but there were no other countries from which to borrow in 1917: US citizens would have to finance the war through both higher taxes and purchases of war bonds.
The Treasury raised funding throughout the war by selling $21.5 billion in 'Liberty bonds.' These bonds were sold at subscription where officials created coupon price and then sold it at Par value. At this price, subscriptions could be filled in as little as one day, but usually remained open for several weeks, depending on demand for the bond.
After the war, the Liberty Bonds were reaching maturity, but the Treasury was unable to pay each down fully with only limited budget surpluses. The resolution to this problem was to refinance the debt with variable short and medium-term maturities. Again the Treasury issued debt through fixed-price subscription, where both the coupon and the price of the debt were dictated by the treasury.
The problems with debt issuance became apparent in the late-1920s. The system suffered from chronic oversubscription, where interest rates were so attractive that there were more purchasers of debt than supplied by the government. This indicated that the government was paying too much for debt. As government debt was undervalued, debt purchasers could buy from the government and immediately sell to another market participant at a higher price.
In 1929, the US Treasury shifted from the fixed-price subscription system to a system of auctioning where 'Treasury Bills' would be sold to the highest bidder. Securities were then issued on a pro rata system where securities would be allocated to the highest bidder until their demand was full. If more treasurys were supplied by the government, they would then be allocated to the next highest bidder. This system allowed the market, rather than the government, to set the price. On December 10, 1929, the Treasury issued its first auction. The result was the issuing of $224 million three-month bills. The highest bid was at 99.310 with the lowest bid accepted at 99.152.
Foreign countries later started to buy US debt as an investment of their surplus US Dollars. There was fear that foreign countries held so many bonds that if they stopped buying them, the US economy would collapse. In reality more bonds were transferred in a single day by the Treasury than were held by any single sovereign state. The perception of this dependence furthers belief that the US and China economies are so tightly linked that both fear the consequences of a potential slow down in China's purchase of those bonds. In her 2010 visit to China, the US Secretary of State Hillary Clinton called on authorities in Beijing to continue buying US Treasurys, saying it would help jumpstart the flagging US economy and stimulate imports of Chinese goods.
As the economic recession continues, more doubts arise over the real value of US treasury securities. Though carefully worded, Chinese premier Wen Jia Bao's warning about possible devaluation of Chinese held US bonds was taken very seriously by Washington:
"Of course we are concerned about the safety of our assets. To be honest, I'm a little bit worried" ... "I would like to call on the United States to honor its words, stay a credible nation and ensure the safety of Chinese assets." - Chinese premier, Wen Jiabao, said at a news conference after the closing of China's 2009 legislative session.
As of April 2009, the US dollar had rallied YTD against all other major world currencies. On March 18, 2009, the Federal Reserve used quantitative easing "to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months."
Read more about this topic: United States Treasury Security
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