07-10-07, 10:42 AM #1
What happens when China dumps U.S T-bonds?
I have a question for the Business savvy. Lately I read in an article that U.S has a trade deficit with China, which means U.S buys more from China than China buys from U.S. This means that a lot of American green backs are ending up in China. And what does China do with all this green backs? They loan it back to U.S in T-bonds. Thus accumulating debt for United States. Now, here is my question- What is the big deal in having a trade deficit and why does the U.S have to finance it? I thought when you pay for something, thats the end of the transaction. So why do you have to pay again for something you have already paid for? Its like buying a pair of shoes from someone all the time, sure you are giving away money, but you have the shoes you bought, and money usually equals goods and services. America's concern over the "trade deficit" with China is alarming. For years America has persuaded the Chinese to increase the value of the Yuan so that importing from China will be more expensive and exporting to China will be less expensive. The game has been going on for decades and nobody borrows money forever, sooner or later the U.S will have to address this issue. Other ways the U.S can address the issue is increasing mortgage rates, interest rates, and genarally slowing down the U.S economy. If the Chinese decide to dump the U.S T-Bonds, the U.S stockmarket will be greatly affected, though experts say the Chinese have too much to loose to do that. Okay, I am having a headache from just trying to understand all this, so I'd ask the same simple question again- Why does any country feel the need to pay for trade deficits, aren't these the excessive imported goods they have already paid for? Unless of cause they haven't paid for it...
07-11-07, 10:30 AM #2
(chirp, chirp, chirp!). Its so quiet in here, I can hear the crickets chirping.
07-11-07, 10:52 AM #3Some contend long term effects of the trade deficits are deleterious. Since the stagflation of the 1970's, the U.S. economy has been characterized by somewhat slower growth. In 1985, the U.S. began its growing trade deficit with China. In 2006, the primary economic concerns have centered around: high national debt ($9 trillion), high corporate debt ($9 trillion), high mortgage debt ($9 trillion), high unfunded Medicare liability ($30 trillion), high unfunded Social Security liability ($12 trillion), high external debt (amount owed to foreign lenders) and a serious deterioration in the United States net international investment position (NIIP) (-24% of GDP), high trade deficits, and a rise in illegal immigration. In 2006, the U.S economy had its lowest saving rate since the 1930's.
Milton Friedman, the Nobel Prize-winning economist and father of Monetarism, argued that many of the fears of trade deficits are unfair criticisms in an attempt to push macroeconomic policies favorable to exporting industries. He stated that these deficits are not harmful to the country as the currency always comes back to the country of origin in some form or another (country A sells to country B, country B sells to country C who buys from country A, but the trade deficit only includes A and B). In fact, in his view, the "worst case scenario" of the currency never returning to the country of origin was actually the best possible outcome: the country actually purchased its goods by exchanging them for pieces of cheaply-made paper. As Friedman put it, this would be the same result as if the exporting country burned the dollars it earned, never returning it to market circulation.
07-11-07, 01:39 PM #4
We can most likly be sure that Interest rates would rise and the USD would depreciate.
That questions requires a very long and complex answer that depends heavily on you outlook on the world, politics, and macro economics. The real answer is that no one knows what will happen because there a number of things that make this situation unique.
You're question also assumes that China will dump treasuries. There are many who would argue that its more a question of if, not when.
07-11-07, 04:57 PM #5
China is not likely to "dump treasury bonds." Most of their now 1.2+ trillion is held in treasury issues, but china is trying to use ever more of the dollars it earns to buy other assets, like long term contracts for oil or Brazilian iron ore etc. Also China has recently established an agency to find more profitable (and risky in the traditional sense, at least) investments. China, for example invested 3.2 billion in the 4 billion Blackstone Group IPO.
There is currently still a need for China to sell much of the production of it factories to US and EU. China certainly does not want to close these factories and throw the masses out of work; however, the real incomes of these masses is rapidly rising as are their numbers. (Almost a million pesants leave the country side seeking jobs in the urban centers every month.)
Real wages in the US have been going down for at least three, possibly 5, years now as the higher paying jobs are out sourced and factories close. The typical American now has a "MacJob," not an industrial or intellectual one. Even the financial service jobs are leaving, mainly the "back office" jobs for India and the "front office" jobs for London, Dueby, etc. (For the first time in its history, Goldman Sacks, earn more than 50% of its income from foreign activities last quarter. etc.)
China will just increase what it is already doing more of every year and probably never dump the Treasure notes and bonds it holds. To do so would be hard as although the market for them is large, there is no country that either wants to or could buy them, unless deeply discounted from their face value.
What will surely happen is that China will use ever greater fraction, and eventually all, of its trade surplus to finance the imports of its raw materials and energy supplies as its economy continues to grow three times or more faster than that of the US. When China is not buying Treasury issue, it will still have many, probably significantly more than a trillion in face falue. As they mature, the US will pay them off in dollars. The real question is: Where do these dollars come from and what will the consequences be?
There are two answers for the "source" part of the question:
(1) From US Mint's printing presses.
(2) From other holders of dollars.
(or probably a combination of both one and two)
To the extent (1) is used inflation is produced. If Ben Bernachie is still leading the Fed, one can be reasonably confident he will fight hard to control this inflation (with high interest rates, which reduce the demand for goods - kill buying on credit etc.)
To the extent (2) is used, inview of the current falling value of the dollar* and 200+ billion fiscal deficits, the lenders will demand higher compensation (interest) for buying the Treasury bonds China no longer will buy. (Ideally the US would balance the budget, but in view of the fact that the social security surpluss will be falling as "baby boomers" retire, stop contributing and start collecting, this is politically if not economically impossible now. Clinton understood and did run balanced budget but GWB is adding to the debt, especially with Iraq etc.)
In any case it is very clear that approximately a decade hence, the interest rates in the US will be much higher, at least double, and the US economy will have negative growth (be in depression). This will of course make foreigners even less willing to lend money to a sick economy, demand even higher interest rates to do so etc. - an unstable feed back loop, which triggers a run on the dollar. (Everyone trying to buy something that will not decline in value as the dollar is rapidly doing.)
The "new world order" will rapid emerge, with Chinese and Indian factories and "brain activities" leading the world economy, producing goods for their own populations and for export to the suppliers of the raw materials and energy covered by the long term contracts being signed now. With weak (collapsed) dollar the US will consume less oil, and import less, probably even enjoy a small positive trade balance by exporting food to Asia and India.
That will also be a necessary fact of life as China and India will need all they can produce for their internal demand and to pay for their necessary imports.
*Already, for the last year or so, the interest rates paid by the Treasury have not compensated for the loss in purchasing power of the dollar as it falls in value. I.e. even the most stupid director of a foreign central bank has already learned that buying US bonds is a sure way to lose value. The only countries that are buying them do so DESPITE this loss in an effort to keep their curency from being too strong. Typically these countries (like China and Brazil) have large influx of dollars and if their central bank does not step in to buy up most of the surplus of dollars, their local currency becomes too strong. (A very strong currency make it impossible to export at a profit, closes factories, etc. - For example Brazil now holds about 130 billion dollars and held only about 50 billion a year ago. Despite Brazil's effort to support the dollar, the Brazilian makers of shoe and textiles are exporting less and some factories have closed. It only takes 1.91 Brazilian Real to buy a dollar now - abut four years ago it took 4. I.e. in Brazil the dollar has already lost more than half its value.)
Last edited by Billy T; 07-11-07 at 05:29 PM.
07-12-07, 02:56 AM #6
Like I said though, that is certainly one possibility. There are many smart people in finance and economics that see things playing out differently.
This really is a unique situation and I dont think that anyone can say for sure how it will play out. Thats why I find all this international finance/economics so damn fascinating. When I graduate next year, this is the kind of stuff I want to get into.
07-12-07, 01:27 PM #7
Please tell some other scenerio, different from mine, in the same detail that I did in my last post (and in many others during the last few years).
07-13-07, 09:57 AM #8
Nice post BillyT. I think the U.S creditors can always find buyers for their T-bonds because too many countries, and I mean, too many countries, have too many interests and investment in America. Brazil is not like China, China is obviously ambitious and will never sell their T-bonds or devalue their currency, they will use this leverage to facilitate their shift to industralization and take over from the Japs as the benchmark of Asia, they have done it before and they can do it again. Though this is tentative since the Chinese government is still technically communist. But to remain communist when you have a billion mouths to feed and half the people are in relative poverty, and with globalization encroaching, its any ones guess what the Chinese liberals will achieve. Right now, America is a cross between the E.U and Japan; its currency is not too expensive to export. Japan is also highly inflated, but Japan makes up for it with its industralization. So the lesson is - If you are going to be infated, you better be industralized and export a boat load amount of goods. Just look at Zimbabwe, they are in a real dung hole because they have the highest inflation in the world and can't export. A very good way to finance the U.S debts will be to incorporate the North American Union to decrease the pressure on America by setting up a N.A central bank, but thats not even necessary at this point. By the way, the black stone group- is there anything those guys don't own?
Last edited by Chatha; 07-13-07 at 10:14 AM.
07-17-07, 11:06 PM #9What happens when China dumps U.S T-bonds?
07-17-07, 11:33 PM #10
More dollars circulating is an inflation driver and the FED will need to raise interest rates to control the resulting inflation. Thus one could say that N. Korea is already making economic war on the US.
07-17-07, 11:51 PM #11
Blackstone group depends on inefficiencies in the market in order to make money. Doesn't seem like a sustainable business model to me. As a private equity group they relied on the difference between the cost to take a public company private and "restructure" it, and how much they can get for taking it public again. Without any real value added (and a lot actually taken away), investors catch on to this relatively quickly. When investors won't buy a company that's been 'Blackstoned,' this trick no longer works. The fact that it's going public tells me that the brains behind it have decided there's more money to be made ditching it than continuing to operate, so it seems like they're thinking the same thing I am. Funny "investment" for China to make, since it'll probably evaporate without them ever realizing why.
The US is more resilient than you give it credit for. When it comes down to it, we have a lot of options for reducing our liabilities - they just aren't very pleasant. Just allowing the dollar to decline a bit, as it has in the last few years, erases a lot of the value of China's US debt holdings. And when it becomes apparent that we may have to balance the budget, social securtiy and medicare will suddenly become less generous, resulting in massive decrease in the associated liability. Between that and military spending, there are large factors that we have control over. We're not at the merci of inescapable future spending.
China's economic strategies don't seem like they'll be as effective as what you say, BillyT. With the value of their US debt getting wiped out by a falling dollar, and the fact that they've been growing in an unsustainable and inefficient manner [rampant pollution, corruption, inequality & civil unrest], they're going to find that they've put their country in turmoil in exchange for a large sack of worthless cash. That's the best of all possible worlds for the US, because in the mean time we've used China as one more way to stay ahead of the game economically, and we've done so in a sustainable manner. We haven't sacrificed our natural resources, social well-being, political stability, or anything of real value. There's a reason the west tries to keep its economies from growing out of control - growth is more stable in the long run when it's done slowly and carefully.
Symptomatic and representative of China's dilemma is the state of the Shanghai stock market (http://finance.yahoo.com/q?s=000001.SS). China has nothing but money, and few options for how to put it to good use. Its people have been dumping billions of dollars into the stock market, thinking it's producing fantastic returns for them. The price increases are merely the result of their own buying - the value of the companies is completely ignored. Price-to-earnings ratios are through the roof, because publicly traded companies can't increase their profits at the rate people want to invest. Every foreigner watching the situation has already taken his money and run - evidenced by the large single-day selloffs. But as soon as they're gone, prices continue to climb on the blissful ignorance of the Chinese investor. As if there isn't enough cash in China, I even read about commoners mortgaging their properties so they can dump even more money into the stock market. After all, it's gone up 300% in a couple of years, who could lose????
Last edited by MrManganese; 07-18-07 at 12:35 AM.
07-17-07, 11:54 PM #12
I think the government will do what it usually does in such cases; pass the burden onto the people with hidden taxation.
07-17-07, 11:56 PM #13
Saying that they could get money back by 'selling the shoes to the public' is like saying you get money back by selling something to yourself. Selling within the US wouldn't really help make more money to get rid of a deficit, would it?
07-18-07, 12:36 AM #14
07-18-07, 01:55 AM #15
I recently did an eye exam on a young lady currently living in China. She was home for a visit and works there as a teacher. She told me that foreigners are treated extreemly well there. She originally went just to do her student teaching and has now been there nine years.
We got to talking about China's role as a future world power and she scoofed at the idea.
She said that the culture there is not only corrupt, but regards what we would consider as corruption as a virtue. People routinely hold jobs they are completely unqualified for because a friend or family member put them there.
To not give a friend or family member a job he doesn't deserve is considered an insult.
This creates gross inefficiency and will hold them back from attaining the power they seek, at least that's her opinion.
07-18-07, 03:37 AM #16
Every cent the USD drops equals billions the Chinese lose in the bonds they bought. Basically it's free money to the USA. China does this because one day they will call in this favor. At this time the USA will let them get away with stuff we normally wouldn't be it human rights for the Chinese or allow them to put the smack down on Tibet or who knows ???
07-18-07, 04:49 PM #17
So long as the US maintains itself as a capitalist democracy, we will remain strong. Freedom is the reason we are wealthy. It gives us enormous flexibility and frees the hands and minds of millions Americans to innovate and work hard.
That is our strength, not the petro-dollar or our trade balance.
09-10-07, 12:02 PM #18
Thus US has large surplus of lawers and Wall Street types, etc (as their average salaries are higher than most other fields) than any other country and is lacking* workers in IT and enginneering so it imports them. Unfortunately, as salaries and hate for US rise, more of the Indian, Chinese, S. Koreans, Japanese, etc who formally came to US to study and then stayed to live and work in these fields where US native born workers are lacking are no longer doing so in adequate numbers*. (The "native born" became lawyers, brokers, salesmen, ad-writers, PR-reps, CEOs, etc as they were "free to do so")
NOT all of the "US's freedom" is positive for the long-term economic health of the US.
Also the "non-US freedom" enjoyed by the foreign rulers, if not their populations, specifically their central banks is begining to adversely effect the US economy. Some Americans tend to think / assume that these central banks MUST buy US Treasury bonds with the trade surpluses their countries are earning, but this is not so. See my "Sovern Funds ..." thread at:
Or read the following, quoted from today's Bloomberg:
"... holdings of U.S. bonds by governments and central banks at the Federal Reserve fell 3.8 percent, the steepest decline since 1992. The dollar's slump to a 15-year low against six of its most actively traded peers is turning the gains into losses for international bondholders, prompting China, Japan and Taiwan to sell. Overseas investors own more than half of the $4.4 trillion in marketable U.S. government debt outstanding, up from a third in 2001, according to data compiled by the Treasury Department. ..."
If these four ;largest holders continue to be net sellers of US Treasury paper, then interest rates will rise to to persuade someone else (or them) to buy (assuming that US continues to to spend more than it earns ) With the Iraq war consuming all the munitions that were in surplus, etc a balanced budget or traded is nearly imposible. - I.e. the "twin deficits will continue. To a large extent it is also your freedom to shop in Wal-Mart and import French wine etc. that also guarantees that the US dollar will collapse. Ironically, your lack of freedom to drive your car on much chaeper alcohol from tropical lands is also part of the problem, but at least privately owned Cargill and ADR etc are getting rich on your tax dollars paid to them to subsidize the corn from alcohol industry, behind the $0.54 per gallon protective tarrif wall. (I will not dwell on the rising cost of your food resulting from this "welfare fro billionaries" as you surely notice that when you go to the grocery store.)
But do not let the facts shake your faith that "all will be well" as US has "Freedom."
*As I recall, Bill Gates, when announcing the opening of large new IT development center in India, said he was forced to do so as there was a shortage in US of more than 10,000 qualified workers for MicroSoft's needs in next few years. (Billy T adds: but not of lawers or brokers to help manage his fortune and write the contracts exporting these high pay jobs.)
Last edited by Billy T; 09-10-07 at 12:28 PM.
09-10-07, 01:32 PM #19
09-10-07, 04:37 PM #20
The litious nature of US society is of course also prompting the very dis proportionate amount of lawers in the US compared to any other modern society. I forget the actual numerical ratios but the ratio of lawers to engineers in US is much higher than that ratio in Asia and EU.
When you get right down to it in the economy the lawers mainly try to influence how the pie is divided (one working for client A against another working for client B) rather than "produce any pie." - IMHO, too much of young US brain power is being diverted to getting skilled at "pie splitting" instead of "pie making," especially when compared to the societies that the US must compete with.
I admit that Japan also has strong "old buddy" "old family" based economy, but for reasons not clear to me, has not become over loaded with legal actions and lawers. (see edit addition)
Following may explain: Many business leaders in the USA did graduate from a good (internationally the best) "Business School" - Perhaps there are relative few in Japan and the typical CEO of a major Japanese company may come up thru the ranks rather than be a Business School graduate, brought in from outside the company? - Just a passing thought as I do not know if Japan has few Busniess Schools.
I do recall there was recently a lot of talk in Japan (because it was so unusual) when Sony (I think) hired a graduate of a US Business School to be its new CEO instead of promote from within Sony. Thus the value a top school lawer brings becase of the high level connections he (or she) made in school to the CEOs and decision makers of his generation may be almost nill if the Japanese CEOs and decision makers come up thru the ranks. I.e Japanese lawers may be paid for what (rather than who) they know.
As I understand it, however, the entering Japanese workers have far from equal chance on merit to some day be the CEO - only those from the "right families" have this chance, even though the "wrong family" ones also loyally stay with the company 40 years and are very skilled.
Last edited by Billy T; 09-10-07 at 05:11 PM.