Why China Needs U.S. Debt
realclearworld.com
realclearworld.com
Am I the only one who thinks something is deeply, fundamentally deranged over here? If the global economy were a computer program, it would be time to throw out the old code and redesign everything from scratch.
Investing in a first world infrastructure would stimulate growth at home and lessen their reliance on our consumers (whose buying habits have recently become rather fickle) and our Treasury. The second part may be more important too, with our country hurling toward a Social Security meltdown. Our debt as a percentage of GDP might be low now (relative to Japan) but check back in 20 years.
I'm not an economist, but I'd love to hear from some why I'm wrong (which I'll assume I am).
Problem : the more people buy Chinese goods, the higher the Yuan is supposed to get. Therefore, they would lose their initial competitive advantage, because a higher Yuan would mean more expensive Chinese goods. It's the classic path for any prospering country, at some point it has to become a "normal" rich country, adapting to a lower growth.
Solution : China buys a lot of US debt so it can artificially deflates its own currency. Because they sell a lot of Yuans, their currency is deflated = chinese good cheaper to the world = strong demand = especially from the US because of the stronger $, Americans can buy more Chinese goods.
You see it's a complex situation, and we can even argue it's a kind of win-win situation because Americans can afford more goods as well. But this strategy is unsustainable in the long run and could damage both countries if the worst case scenario happened.
Basically, China has been holding the ball underwater with the consent of the Bush administration, because of the susmentioned "win-win" deal. A lot of economists have been very critical of the former administration because such large amounts of money could put America at risk. Now that the crisis has stroke, this threat is more pertinent than ever.
Anyway, the Chinese governement has absolutly NO lesson to give to the Americans in this case, it was entirely their initiative and no one forced them to buy US debt, it was their own strategy, and it didn't come with any sort of guaranty that the $ would remain strong. The American people could blame the Bush administration for letting this situation happen tho, but everybody enjoyed it trough an increase in buying power.
Some number of dollars flow into their country every year. Some number of dollars flow out. The difference effectively ends up in the hands of the government. They have to do something with it... because if they do nothing with it, they are effectively exchanging Chinese goods for nothing more than cheaply printed pieces of paper.
They government can't spend US dollars inside of China. The only thing they could do is buy American exports, and American assets.
If China were somehow to launch a stimulus plan that was fueled by American production, than that would have the effect you are suggesting. They could have Americans come over and build their roads and schools for them, with American materials. They would improve their infrastructure and we would get our money back. But this is impractical, and China gets the long-term benefits, not us. In fact, we get screwed in the long-term, because the return of all those dollars to America would cause inflation.
All investing them does is get them even more US dollars. If the problem is that they can't spend US dollars in China, how does using those US dollars to collect more US dollars help at all?
If the Bank of China were to spend US dollars domestically, it would be exactly equivalent to printing Renminbi and spending it. It would be just like a stimulus plan. There's nothing different. Remember, Bank of China must print all the Renminbi necessary to keep the exchange rate at the peg. So watch this:
1. Chinese government spends 100 million USD for public works project 2. Businesses receive 100 million USD, want to convert it to CNY, bring it to USD-CNY exchange market 3. Government prints CNY to soak up 100 million USD
We are right back to where we started, except now there is more CNY in circulation.
Now if we relax the assumption in step 2 that businesses want to convert to USD upfront, we still have the same problem, because it just delays the conversion. While USD is in circulation, there will be some converted to CNY at every transaction (for wages and taxes and things like that).
If the government wanted to enact a stimulus plan, and I think they already did, then they should just do it in CNY.
Note: China does not maintain a strict CNY-USD peg. CNY is pegged to a basket of currency.
Still, once these regulations prove too onerous to maintain (which they will) and once China's economy stabilizes, we will suddenly find that half the US is owned by China and that will cause the labor markets to shift again possibly moving production back to the US and away from China. Still, thats ~20-30 years away and who knows what else might happen in that time.
This is exactly the kind of strange situation that happens when you're dealing with global economics which is so hard to understand for people that are only used to dealing with their own finances.
I really have no idea what is going to happen, but its not going to be anything the typical doomsayers predict.
If the Chinese start to believe that the US government deliberately heats up inflation putting pressure on the dollar, trust would be eroded pretty quickly.
The entire phenomenon can be thought of as the USA exporting inflation to China.
On a smaller scale, this is actually a good idea. It's known as building a foreign currency reserve. It serves as buffer against inflation. If the Renminbi were to spiral out of control, they could adjust the peg, give US dollars back to the people in exchange for large quantities of Renminbi, and just retire the money. People would keep their holdings denominated in the dollar until things settled down with Renminbi. Every country has foreign currency reserves. In fact, with a stable foreign currency, building a foreign currency reserve is the safest way to inject money into an economy.
Generally, it is thought that Chinese holdings of American debt are far larger than necessary for an effective foreign currency reserve.
As long as US consumers purchase 100s of billions of dollars in Chinese goods (the Chinese->US trade was 340 billion in 2008), China will continue to run its factories at full-blast.
Welcome to economics.
Just remember China is not stupid and they feel their long term goals are tied with holding a lot of US debt.
PS: Another advantage is they can avoid military and diplomatic confrontations with the US and the rest of the world without a strong military. Compare the US military budget with the trade imbalance and it's not a bad deal.
Why? If they create stuff, and don't print any money, then shouldn't their currency deflate? For each bit of currency, there is more wealth.
If they hold that cash without lending it then the US government would need to create money to avoid deflation and the Chinese would lose out on the interest they would get by loaning the money. Effectively this is loaning the US money at zero interest while the the USD they hold is deflating.
They can use some of this money to buy raw materials or intangible assets, but if buy finished products then the cost of raw materials would increase and they can just pirate most movies / software without cost.
PS: US debt is one of the few places you can safely hide a frighting amount of money. People have been buying notes whose interest rate is well below inflation even as the US borrows insane amounts of money to deal with this mess just for the safety.
US debt is just government bonds, etc. The US govt holds China's money, and promises to pay the interest on those bonds when they mature. China owning US bonds actually makes it harder for them to purchase companies and properties in the US (they have a limited amount of free capital). If anything, the Chinese would avoid buying US companies - they would much rather concentrate on building up their own companies.
The Chinese have a few 100 billion dollars invested in US bonds (a tiny fraction of US GDP) mostly because it is a very safe investment. Why is it so safe? Literally, the only reason is that the US can print more money to pay back its debt. US bonds are the safest place to keep money because the US has proven to be such a stable country. Worst case scenario (other than the US collapsing, which is not likely), is the government will print more money and devalue the dollar.
The bubble started sometime in the 1980s when it became clear that the US was unlikely to ever run a trade surplus. Its been inflating ever since.
Also, bonds are just a proxy for cash. There is effectively no difference except the bonds get interest. Banks are not an option because any cash over $250,000 will have little guarantee. If China ever wanted to purchase US companies, the US govt. securities market would be more than happy to exchange the bonds for hard cash. Also, why would the chinese avoid buying US companies once their economy stabilizes and goes down from the double digit growth? They will buy whatever is most efficient and with their abundance of capital, that may be mean greater investment in American and European stock-markets.
Also, being able to print more money does not make an investment safe. It makes it crap. Read the last sentence you wrote. The key phrase is "devalue the dollar." What exactly is a devalued dollar worth? you tell me but it's not much and it's certainly low enough to wipe out the investment. US bonds are a safe place keep capital because the US government has a reputation of maintaining currency values and honoring debt. A reputation that is more and more divorced from reality as time goes on. Remember something: money != wealth. Also the Chinese government has a few 100 billion (which by the way is not an insignificant amount, have you ever had even a billion to spend? I wish I did.). The Chinese public also has a lot of capital floating around and when considering the country, that capital must be counted.
The US debt accumulation process runs like this.
A Chinese exporter of electric goods (for example) has its revenues in US dollars but his costs are mostly in Yuan. As he receives money from his American customers, he sells dollars to buy local currency to pay his workers, to pay taxes etc. Without Chinese central bank intervention the collective activity of exporters would drive Yuan rate up vs dollar very quickly and that would make their exports less competitive.
Chinese central bank wants to keep exports competitive, so it buys US dollars from the exporters at artificially high rates. Its 'foreign currency reserves' keep growing as long as there are exporters bringing in piles of export revenues in dollars. All these dollars needs to be bought up in order to keep Chinese exports competitive. And then all these bought dollars need to be invested, the US Treasuries being the natural place for it.
This all works as long as US consumer is buying. But the US consumers have stopped buying like they used to for many years and some say forever. No major revenues are expected from exports to the US. No need to buy dollars for the Central Bank.
In fact, the opposite is likely to happen. Chinese domestic consumption is growing fast. Very soon domestic Chinese market will become the biggest target for the world's exporters, just as US post-war consumer was. Chinese central bank may want to stimulate local consumption and capital inflows by switching to 'strong Yuan' policy, just like US did with its dollar. There will be no point of spporting the USD and holding dollar-denominated securities (US treasuries) for them.
To summarize, Chinese investment in US treasuries is not a result of desire to find a 'safe heaven' for extra money. It is because they need to park all that greenbacks the accumulated during years of keeping the Yuan down. Today they do not need to support USD anymore. They have no reason to buy US debt either. Prepare for a nasty surprise.
It all sounds familiar, somehow.
It doesn't sound like you're correct though. At least S & P suggested that the U.S. might lose it's AAA rating. (Note also the article is from 2006, while we were still in the boom.)
http://www.savings-bond-advisor.com/us-credit-rating-could-d...
Sometimes. Sometimes not. http://en.wikipedia.org/wiki/Credit_rating
The Credit Rating wikipedia page does not show him to be wrong. Also, the fallacy linked to is not applicable. Would you care to elaborate?
Was linking to the Credit Rating wikipedia page intended to show someone to be wrong? The Credit Rating wikipedia page indicates that credit rating can be defined in more than one way.
Would you care to elaborate?
Do you know what equivocation is?
Deleted comment
>> Sometimes. Sometimes not.
> you replied that it is not.
No. I replied, "Sometimes. Sometimes not," intending to imply that it is not always defined in only one particular way, and that to do so would be to fallaciously equivocate. http://en.wikipedia.org/wiki/Equivocation_fallacy
Start paying off the debt that China currently holds and take American dollars off of the market, which would cause their currency to increase in value because of the peg. Continue this policy with other countries that peg their currency to the American dollar as well.
Enact the FairTax which would allow corporations to produce goods and services here with a 0% corporate tax rate instead of importing those goods into the United States.
Increase tariffs on countries who peg their currency to the American dollar, to produce and export goods cheaper, so that the United States can have the competitive advantage, with corporations, on the global market thus creating goods and services here.
1. Buy precious metals such as gold and silver and then take physical delivery - COMEX is required to accept US debt as an equivalent to cash. This would raise the price of silver significantly - you can just about corner the market for silver with about $5B to $6B. Buying even a fraction of the gold that China has stated they wish to acquire would send the gold price soaring.
2. Buy other assets such as real estate, commodities like copper, aluminum, steel, wheat, chicken legs, etc. Competing with Americans and Europeans for some of these commodities would also drive the price up.
Bottom line: inflation is coming to America and possibly Europe (which may be in better shape) as well.
This is not as far fetched as it sounds. The savings rate of Chinese Gen X'ers are 0. They are voracious consumers. If Chinese goverment decided to fund local debt instead of foreign debt, U.S. manufacturing could conceivably come back and sell into China in the future.