Sunday, July 31, 2011

China Will Not Unload Its US Government Bonds Because of the Debt Ceiling Crisis

31 July 2011

I thought I should write this while the debt ceiling debate is still raging. I want to make these statements before the matter is settled.

To begin, the debate over the ceiling is for real - it's not a charade. The Tea Party folks were elected to reign in US government spending. They aren't faking.

Further, let's say a deal is not reached by August 2. This would not necessarily mean that US government bonds would collapse in value. Continuing revenues could still be channelled to meet interest payments on US debt (which are presently only about 10% of US government expenditures - though solely because interest rates remain low).

Since the US prints its own money, it is well-known that the country cannot run out of cash (it can only run out of cash that has lasting value). This is unlike Greece, which shares the Euro as a currency along with the other members of the European Monetary Union. Greece cannot “print money,” but the US can.

However, there has been talk that the Chinese, who now hold something like $1.2 trillion in US debt instruments, could “foreclose” on the US, basically tanking the US currency and with it the US economy.

This argument misapprehends why the Chinese have accumulated $1.2 trillion US dollars in the first place.

If you want to understand this better, I recommend that you read an excellent article by a professor at Tsinghua University's School of Economics and Management in Beijing. In a very concise piece, Professor Patrick Chovanec makes clear why the current Chinese economic strategy not only requires China to keep its existing US government bonds, but in fact to continue buying more (though they are certainly diversifying).

Professor Chovanec states, "China’s growth model for the past 30 years relies, in large part, on running a trade surplus (selling more than it buys from abroad) in order to maximize capital accumulation and therefore investment at home. At the same it, it encourages inflows of foreign investment into China in order to speed up that process even further, while restricting Chinese money from flowing abroad, in all but a few controlled circumstances.

"The result is that foreign currency flows into China and piles up, with no outlet to flow back out again. Normally, all those excess dollars that were piling up in China would fall in value relative to the RMB, until the imbalances corrected themselves. However, in order to keep those imbalances in place, the Chinese government intervenes to buy up all those excess dollars (and euros, and yen) itself, to keep its currency from appreciating, and accumulates them as official reserves. It has to invest those reserves somewhere until it decides to use them to buy U.S. goods or make more direct investments with them abroad.

"Since the U.S. is China’s largest customer, and since many smaller customers also settle their international trade in U.S. dollars, roughly 70% of China’s $3 trillion reserves are in dollars. In theory, it could sell some of those dollars for other currencies or for commodities, like gold or oil, but in practice, given the huge sums they are already holding, its hard for China to sell off even some of its dollars without undermining the value of what it has left. Even if it could do that, there just aren’t any markets that are as large or liquid as the market for U.S. Treasuries, to accommodate the amounts of money we’re talking about. The fact is, as long as China wants to sell goods for dollars, and decides to accumulate those dollars as reserves rather than spending them on imports or investments, it has little choice not only to hold the Treasuries it already owns, but keep buying more and more."


I'm not saying the US is not headed down the road to disaster. It is. Things have already gone too far. But the Chinese are not going to upset the applecart next week, whether the debt ceiling is raised, eliminated by presidential decree or maintained.

Click here for Prof. Chovanec’s article.


Oh, just in case you thought that the Tea Party folks are really here to fix the problem, have a look at which party ran up the biggest tally of new Federal expenditures in US history:

I'm not calling Mr. Obama innocent. He has certainly been a big spender - but he has been no match for the George W. Bush Republicans! As they say, politics makes for strange bedfellows.


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