Free Markets, Free People

Understatement of the Week

China expresses some … um … “concern” about whether or not it will ever see its money back:

The Chinese prime minister, Wen Jiabao, expressed unusually blunt concern on Friday about the safety of China’s $1 trillion investment in American government debt, the world’s largest such holding, and urged the Obama administration to provide assurances that the securities would maintain their value in the face of a global financial crisis.

"How much chance China get repaid?"

How much chance China get repaid?\


Speaking ahead of a meeting of finance ministers and bankers this weekend in London to lay the groundwork for next month’s G20 summit, Mr. Wen said he was “worried” about China’s holdings of United States Treasury bonds and other debt, and that China was watching economic developments in the United States closely.

“President Obama and his new government have adopted a series of measures to deal with the financial crisis. We have expectations as to the effects of these measures,” Mr. Wen said. “We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.”

Just a little? There’s an old saying to the effect of “if you owe the bank $1 Million, then the bank owns you; if you owe the bank $1 Trillion, then you own the bank.” China’s feeling pretty nervous because it knows it can’t sell its holdings except at a tremendous loss — both from the normal discount expected, and from the fact that it is by far the largest mover in the market (e.g. what do you think would happen to Microsoft stock if Bill Gates started selling off?) — and it doesn’t see a whole lot coming out of Washington to instill confidence.

But there’s no need to fret PM Jiabao! Unnamed economists are here to save the day:

While economists dismissed the possibility of the United States defaulting on its obligations, they said China could face steep losses in the event of a sharp rise in United States interest rates or a plunge in the value of the dollar.

Whew! That was close. Nothing but a little market risk to worry about there, Jiabao. Default? Pffft … never gonna happen.

Back in the land called “reality” however, default is plays a bigger part since, aside from reneging on the debt, there are only three other ways for the government to pay for its spending binge: higher taxes, printing more money, or borrowing. Higher taxes impedes growth and leads to less revenue. Printing money leads to hyper-inflation. So, even though those two choices will be used to a certain extent, further borrowing is the only viable alternative to default. But who’s going to lend to us?

Maybe China?

The bulk of China’s investment in the United States consists of bonds issued by the Treasury and government-sponsored enterprises and purchased by the State Administration of Foreign Exchange, which is part of the People’s Bank of China … much of the Treasury debt China purchased in recent years carries a low interest rate, and would plunge in value if interest rates were to rise sharply in the United States. Some financial experts have warned that measures taken to combat the financial crisis — running large budget deficits and expanding the money supply — may eventually create price inflation, which would lead to higher interest rates.

This puts the Chinese government in a difficult position. The smaller the United States stimulus, the less its borrowing, which could help prevent interest rates from rising. But less government spending in the United States could also mean a slower recovery for the American economy and reduced American demand for Chinese goods.

It may just be the case that China’s best option is to support its investment by propping up its best customer with yet more loans. Unfortunately, that means that Washington will have little incentive to slow down spending (since it owns the bank). The nasty little cycle of borrowing > spending > inflation > rising interest rates > falling dollar, will continue necessitating even more borrowing. China, in turn, will have serious questions about the value of its investment, and the US will start having serious discussions about declaring a default.

In short, China’s not just “worried” about the current fiscal mess. It’s crapping its collectivist shorts.

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28 Responses to Understatement of the Week

  • In other unrelated news, foreigh policy experts say they expect few exhortations about China’s reprehensible human rights violations from the current administration…

  • Japan and Great Britain also hold a significant amount of US debt. Given that all three are facing difficulties of their own, it is hard to see how they are going to be buying any more debt, much less holding the amount they already do.  So, in addition to inflation, we can also expect to see interest rates rise.

  • I just trademarked a new acronym:  EMADtm

  • “It’s crapping its collectivist shorts.”

    Will that be delivery or take-out?

  • After the Prussians spanked the French the first time in 1870, the villainous Boche levied a huge war “reparation” on Paris in an effort to ensure that their chief continental rival wouldn’t rise from defeat for generations.  The French made a superhuman effort and paid the debt in (IIRC) less than a decade.

    I realize that our national debt is huge, but imagine how much stability and confidence would be inspired in the world markets if we set up a plan to pay the damned thing off – or even reduce it by an appreciable amount – in a set and reasonable amount of time, instead of looking for more people to lend us more money?

    Not that it’ll ever happen, of course, but dream a little dream…

  • DocJim, and how do we do this? I’m holding a T-bill for a reason. The only way to pay it off, in a reasonable time, that is not the maturity date is to buy it early…why would I give it up, early? Unless, of course, you were going to offer me a great deal. And even then I might not CHOOSE to let you buy it back…I like the security. And if you offer me a great deal on my T-bill, well with the excess profits, I might just buy some MORE. This isn’t a car loan where you can make an extra payment a year to reduce your total indebtedness.

    And so what is the “reasonable” time of which you speak? How about the maturity date of the bond, short or long?

    • Joe,

      I certainly would like to hear the opinion of those who know more about this subject than I, but it seems to me that our debt – parts of it, anyway – is quite “mature” and ready to be paid off.  Further, while lenders often like their debtors to keep a debt rolling along (earning interest the whole while), they don’t kick and scream too much if it is paid off, ESPECIALLY when they start wondering if it will be paid at all.  Finally, if we had to pay some sort of national “early payoff fee” for retiring our debt before our grandchildren are in their graves, I think that would be a small price to pay.

      The national debt is approximately $11 trillion (and a curse upon us for being foolish enough to get in that far over our heads, for allowing successive presidents and Congresses to get us into such a fix).  Uncle Sugar took in about $2.5 trillion last year.  This points to easily being able to retire the debt – or at least seriously dent it – within a twenty years if Uncle Sugar would merely do what every responsible person does when he’s in debt: stop adding more debt and start paying it off, even if that means making significant cuts in spending.

  • THe US won’t default, but if Obama’s gamble on spending a trillion on a stimulus fails, inflation, perhaps relatively severe inflation, might indeed eat away at China’s assets.  That’s what keeps me on edge here — Obama is making a reasonable gamble — focusing on trying to restructure and restart the economy rather than just increase consumption.  But after 25 years of a “fake” bubble economy where people mistaked “net worth” for real assets, it may fail.  And then we could go into a very steep decline.  How the mighty have fallen.

    • Oh, goody. Obama is gambling with our economy. And ballooning our debt. Rock on!

      • Well, doing nothing would be a gamble too.  And we elected him to make tough calls.  At least he’s not spending a trillion to kill, destroy, maim, and weaken our country like the last guy.

    • restructuring the economy?  That’s what i’m worried about.  We’ll back to bartering cause cash will be worthless.

      • Compared to the damage that Reaganism (prosperity built on debt and trade deficits) did, it probably is worth it.  History will treat Reaganomics very poorly, it created this mess.  At least finally that is out in the open.

        • Previous Erb predictions:

          Sadr will have more influence in Iraq than Maliki
          troop reductions by 2008 (manufactured “peace with honor”)
          oil prices will remain above $100

          • Wow, JWG, that’s the best you can do?  I’m sure I’ve been wrong on far more predictions than that (though, frankly, I don’t recall predicting that oil would never go below $100, especially in a severe recession — but I’ll take your word for it).  Yeah, I thought we’d get out of Iraq earlier, but I’m still not sure that Maliki is going to end up stronger than Sadr in the long run, so that one is still possible.

            But gee, if you take some time and read through my blog for the last year, I’m sure you’ll find more predictions I’ve been wrong about — anyone trying to analyze and make calls on the future will be wrong, it’s hardly a big deal to find a few (remember, we’ll be greeted as liberators, it’ll be an easy victory, Iraq will be a model, it will force Iran and Syria to change, Obama can’t win, etc., etc.)

        • Scott,

          With that comment, you just told everyone how economically illiterate you really are.

          All of our debt problems are a function of spending.  Revenues increased dramatically with lower tax rates.  Spending increased faster. 

          Even Charlie Gibson understood this when questioning Obama, who appealed to his sense of fairness versus accurate economics with his answer.

          I suggest you go back to school.

          • Actually, Barrett, you show economic illiteracy with a blanket claim that lower tax rates increase revenue.   That kind of really ignorant thinking is part of the problem with the current “something for nothing” generation.   As someone who teaches political economy, I make a point to correct that falsehood at every opportunity.  Lower tax rates CAN at times increase revenue, but they can also decrease it.  Of course, in the Reagan years as we recovered from a recession revenues increased, but that was the recovery, plus the fact Reagan was engaged in heavy deficit spending, sort of like charing more than your income each month.  That created higher revenues – but not enough to cover the new debt, which rose from 30% of GDP to 60% of GDP.  Moreover, we now have seen that the ‘wealth creation’ touted by the right was fake — it was a bubble economy.  You simplistic approach has been debunked by history.   Now  it’s time to clean up the mess.   Now, I suggest you learn REAL economics.

    • “But after 25 years of a “fake” bubble economy where people mistaked “net worth” for real assets, it may fail.”

      Mistaked?  Thanks professor.

      Interesting how you predict Reaganism will go down in history as a failure, while at the same time praising Carter as a great president.

      • You know, me again, that point on net worth having been fake assets was also made by the Austrian school (following Hayek’s approach), and unlike simple minded libertarians who believed the market was bringing us real wealth the last twenty years, they know it was a  fraud.  I’m actually siding with libertarian economists here.   (A good example is the famous video of Peter Schiff taking on the idiocy of small minds like Arthur Laffer and Ben Stein.)

        • Look Scott – Reagan lowered taxes, which increased the amount of tax revenue to the government.  Just because the idiotic congress chose to continue raising spending doesn’t make the concept wrong.  And I’m not arguing with you that a lot of the current state of things is based on the unreal gains that were made over the last 15-20 years.  But if you are going to sit here and tell me that government should be MORE involved and that government should decide which companies succeed or fail, I’m gonna call you an idiot.

          • Me again, it’s interesting that you will call people an “idiot” just because they have a different view on the role of government.  I personally think smart people can be on different sides of the issue, and the penchant for calling people “idiots” because the disagree is  part of the problem.  Reagan’s revenues rose because we were leaving a recession and the economy thus boomed, and because he was deficit spending.  You cannot prove a causal link to lower taxes.  Moreover, lower taxes can at times increase revenue, but they can also decrease revenue.   In general, it’s the kind of “painless” solution that the right has embraced — wrongly, in my opinion.  Obama says he’ll cut the deficit, and I think he should.  There is a lot of waste in our budget, and our military spending could be greatly reduced.  But right now the economy needs some investment, the I-35W bridge collapse is symbolic of where we are as a country.  We’re in decline, steeply, as I’ve been warning.  Agree or disagree with the recovery act (I tolerate it because it’s not a real stimulus — it’s reinvestment and long term, not a short term consumption bill), but it’s important we reshape things.  All the cheap shots at Obama may make the right feel better, but it really is evidence of a disregard of the real challenges this country faces — and how bad the last eight years have been for us.  I’m not a Bush hater, I think he’s basically an OK guy, but the policies of the lasts eight years are have been based on an illusion we’re more powerful and prosperous than we are.  And now we’re paying the price.

        • Erb, the problem is that the cold hard numbers show you are a liar. Tax revenues DID increase when taxes were cut. Congresses (controlled by Democrats, except in the 4 year period between 2002 and 2006) did jack up the spending. QED.

          • SDN, tax revenues always go up when we come out of a deep recession, they’d have gone up no matter what taxes were.  And if you will credit Reagan for tax cuts, you also can’t absolve him of blame for spending increases.  He supported them, it was his administration that claimed budget deficits were not a problem.  To pretend it was all Congress is dishonest — Reaganism was borrow and spend, and use foreign funds to finance trade deficits.  That defined the 80s and beyond — and is now exploding in our face.   Rather than try to force history into a partisan narrative, realize that Democrats and Republicans were both complicate in this, and the country took a wrong direction.  Partisanship and ideological jihad are part of the problem, it gets each side to evade responsibility and simply point fingers on the other side (and, as this blog shows, engage in ad hominems when the other side makes a credible, strong critique — that’s a sign of weakness, not strength.)

  • This was a power play move.  As Mao said, when the enemy attacks, we retreat.  When the enemy retreats, we attack. 

    Don’t wet yourself. Michael. 

    • This was a power play move.  As Mao said, when the enemy attacks, we retreat.  When the enemy retreats, we attack.

      When it comes to the economy, we’re not enemies, we’re symbiotic beings.  Whatever happens to us has a direct, correlative and immediate effect on China.

      Don’t wet yourself. Michael.
      Umm … OK?  Did you even read the post?

  • China doesn’t purchase our treasury bonds because it likes us, or because it likes T-bills as an investment. They’re doing it to prop up their own currency. The only way you can say my currency is worth X dollars and make it stick is to pay X dollars to whomever seeks to change your currency. I would imagine more than anything the Chinese are worried that we’re going to destabilize the dollar and they’re going to wake up one morning to find the Yuan pegged to a turkey.

    BTW, has anyone noticed that the amount of our debt the Chinese are holding is more or less equivalent ($1.6 trillion) to the amount of sub-prime mortgage debt that’s killing financials? Coincidence? 

    yours/
    peter.

  • China should be worried about their dangerous over investment in US Treasury obligations. Washington ’s long-term choice is either repudiation or monetization. For monetization to be effective, the depreciation in the dollar would have to be substantial and this in turn would dramatically raise prices of imports for American consumers which would mean a tremendous drop in foreign imports. Debt monetization would cause more disruption to exporting nations than selective repudiation of Treasury debt.
    Washington has bailed out the banks, Wall Street & their Washington special interests and much of the cost is added to the national debt to by paid by this and future generations while real estate and investments continue to fall.  Find out what a growing repudiate the debt movement could mean for treasury bonds, the dollar, gold and the stock market.
    The Campaign to Cancel the Washington National Debt By 12/22/2013 Constitutional Amendment is starting now in the U.S. See:  http://www.facebook.com/group.php?gid=67594690498&ref=ts
    Thanks,
    Ron