Monday, March 16, 2009

Chinese debt worries

China is 'worried about' its $1trillion holding of US Treasury Bills.  The Chinese Prime Minister, Mr Wen, complains that the US has spent too much and saved too little - without mentioning that the consumption boom was funded in large part by Chinese lending.  Mr Wen can't sell the debt - its price would collapse - and is presumably fearful that the world's public borrowing binge will eventually drive up interest rates and again inflict huge capital losses on the Chinese holding.  Indeed Mr Wen must continue to lend to the US in order to prevent this happening. I assume the possibility of a collapse in the US dollar, fostered in part by debt concerns and the US option to inflate it away, would also have crossed Mr Wen's mind.

This is interesting. Mr C wants to sell lots of gunk to Mr A. Mr A has a demand for the gunk and buys it by issuing Mr C IOUs at low interest rates. The IOUs are backed up by Mr A's reputation alone but Mr A finds himself in a bind and needs to borrow so much more that the value of the IOUs is called into place because interest rates might now need to be raised.  Even if Mr A defaulted on the IOUs (or more realistically forced their value down) he would not lose a lot. Eventually Mr C would find it in his interest to forgive Mr A and to resume selling gunk again.  Mr A, despite bewilderingly complex current problems, remains well and truly in the box seat.

Afterthought: This situation of the weak exploiting the strong has parallels but is not equivalent to the US Government bailout of firms like A.I.G..  The US bailed out A.I.G. with $170 billion because the firm was 'too big to fail' and threatened the failure of the international financial system.  The bargaining strength in this difficult situation lies with A.I.G. which is probably the reason they felt they could get away with applying hundreds of millions of the bailout in bonuses to the parts of AIG that created the problem.  And this strength infuriates the bailout-er. Larence Summers says “There are a lot of terrible things that have happened in the last 18 months, but what’s happened at A.I.G. is the most outrageous.” Ben Bernanke says similarly “Of all the events and all of the things we’ve done in the last 18 months, the single one that makes me the angriest, that gives me the most angst, is the intervention with A.I.G.” But the bailout must proceed!

8 comments:

conrad said...

I think you are far more optimistic than me about potential outcomes, and "Eventually" is really the optimum word here. Even if China cut-down it's purchases of treasury bills (and say, started buying up the world's mining and other assets instead, like now), and spent a few years thinking about what to do (quite possible given the pace of Chinese politics), it would have huge consequences for the US. This would be even moreso if they started trying to invest more in China than foreign countries, which no doubt is high up their agenda -- indeed, this is exactly what is happening now (just go to their universities, and compare their training system and graduates of it to those from places like Australia)

In addition, I'm surprised you think the US could really inflate its way out of this mess without major problems. How many years of problems do you think this would cause?

derrida derider said...

Oh yes, China's hour is coming, despite the transitional problems it faces. Dreadful economic and foreign policy has hastened the decline of US hegemony.

So bye bye the "Great and Powerful Friends" defence doctrine for Australia (not that it hadn't already outlived its usefulness). I see our Navy is trying to justify buying more subs by saying they'll help the yanks defend Taiwan. I hope the government is not so stupid as to buy that line.

Given their demographics though I think we'll just have the "Chinese decade or two" to replace the "American century". I'd bet it'll be South America or perhaps India after that.

George W Bush said...

"well and truely in the box seat"

Harry, I think you mean "truly".

jc said...

Conrad,

If the Chinese stopped buying US treasuries right now it would have next to no effect.

The world's balance of payments squares out to zero which means all capital account surpluses equal capital account deficits.

If the Chinese decided to buy Euros instead the Europeans would end up buying US dollars. It would all come out in the wash.

The Chinese have a right to be worried as the US is going to screw them royally... upside down, sideways and every which ways.

The Americans will simply inflate away the value of the holdings over the next decade to about 1/2 in today's dollars.

The Chinese know this , however it serves them right in way for allowing the Yuan to stay so artificially weak for so long.

conrad said...

"If the Chinese stopped buying US treasuries right now it would have next to no effect"
.
That's good. People needn't worry then I guess. Interest rates will remain low and the US dollar high. Just like magic. I guess we needn't even worry about a hundred billion more or so on AIG (amongst other slops), since it won't matter anyway.


"The Americans will simply inflate away the value of the holdings over the next decade to about 1/2 in today's dollars"
.
You mean run a stable inflation rate of 7-8%? Good luck.

jc said...

Conrad:

the country running the the deficit with the US doesn't have to be the country buying the Dollar to cover the deficit.

I don't understand why you're getting so snarky about it as it's just a fact.

People needn't worry then I guess.


That’s right, they don’t have to worry from that perspective , no.

Interest rates will remain low and the US dollar high.

The projected US deficit has halved, and the US savings rate has risen to about 7% from zero. That adjustment is hugely painful and is one manifestation of the global slowdown. Yes, it does look like the US dollar will remain relatively strong because everything else that’s in contention like the Euro and the Yen look like a pile of dog turd. Japan’s fundamentals look absolutely awful and and Europe has its own sub –prime with Eastern Europe and the EU economy (you know that fury little social democrats paradise) is very inflexible compared to the US so it will be mired in recession a lot longer. The Euro is also risky as no one is certain if it can sustain a deep recession. So the US dollar wins the beauty contest of uglies.

just like magic. I guess we needn't even worry about a hundred billion more or so on AIG (amongst other slops), since it won't matter anyway.

What the hell does AIG directly have to do with the US trade deficit?

hc said...

Homer I cannot find that spelling mistake.

Randeg said...

Can anyone blame the Chinese for worrying about the US debt? I'm kind of glad though that their hands are tied in the sense that they have no other option but to continue lending or else they will suffer with the collapse as well. But really we should be careful about spending money like the one given to AIG. They had the nerve to say that their Board of Directors approved this. That's why there should be a regulation to limit the term of office for these people. The other thing that made me cross is the reason why they gave out these bonuses. And that is, they have already approved it before receiving the bailout. Give me a break! Do they think we are idiots to listen to that? In the first place, if their company is in trouble they have no business thinking about bonuses and for not doing a good job of keeping their company afloat!

Evelyn Guzman
http://www.debtchallenges.com (If you want to visit, just click but if it doesn’t work, copy and paste it onto your browser.)