The most important metric is excessive inflation, and the secondary one is exchange rates (though changes in that have mixed effects). These are empirical facts of the matter.
There's lots of theories about how this or that or the other thing might cause high inflation and/or devaluation. But when you look at the track record of these theories they are pretty horrible. QE1 and QE2 was supposed to lead to imminent hyperinflation. It didn't happen. The S&P downgrade was supposed to lead to yield spikes in treasuries (which in turn was supposed to lead to heavy inflation). It didn't happen. Deficit spending was supposed to lead to bond vigilantes coming out of the woodwork and cause catastrophic inflation. It didn't happen.
As a formal matter the government doesn't even need to issue bonds. Under this view (which broadly speaking goes by the name MMT) the government doesn't have a budget per se at all. When a bill comes due they can just create dollars out of thin air to pay it. When taxes or other fees are paid to the government they don't get stored anywhere to be used to pay bills, but instead cease to exist. Advocates of MMT suggest that the government tweak outflows and inflows not with the aim of balancing a non-existing budget but rather based on managing observed metrics (mainly inflation).
Critics claim that a move to such a system would cause hyperinflation. Who knows, they might even be right for once. The important take away is that the US government is not just a really big household, and US treasury bonds are not just like a credit card.
The reason we haven't seen inflation is that, despite all the printing, the money supply has not increased since 2008. This is because the velocity of money and the money multiplier have both decreased significantly since the financial crisis -- in essence, people are not borrowing or spending the way that they were in 2008. If people aren't spending, you aren't going to get inflation... until you do.
Some people believe that China buying US government bonds is a favour to USA as it allows the US government to spend all of this money coming in on various government projects, such as military spending and social security. If China stopped supplying that money, the US government would have to print it themselves (for free), which would lower the value of US currency. Some people believe this is a good thing, and others believe it's a bad thing. There are so many complex and mostly untested effects at play that I'd be a bit worried if anyone claims to have the one true answer here.
Pro for China buying bonds
- US government has more money to stimulate economy
- US dollar remains strong, so buying from offshore is cheap
- Higher quality of living in USA means more people can
spend time inventing new industries
Con for China buying bonds
- US dollar weaker, US firms are under-priced when exporting
- When China stops buying bonds it will cause a shock effect
on US economy
- Higher quality of living in USA means less people are forced
to invent new industries or starve
- US government is wasting the money on stuff like TSA instead
of using it to grow the economy
These are just off the top of my head. There are far more effects and knock-on effects. Anybody trying to tell you this stuff is simple just doesn't understand it themselves.
The US offers bonds in $ at a certain very low interest rate and China buys them in order to maintain their low yuan valuation. As stated in the article, this is to manipulate currency prices for domestic reasons to keep their exported goods "cheap" in terms of the global reserve currency, dollars.
Your cons are all messed up. They're making the dollar stronger and the yuan weaker, deliberately, and that makes our firms over-priced when exporting. We've had 1% inflation for like 5 years now.
If they didn't have that industrial policy, we'd probably have to be selling our 30-year tbonds at 3-4% instead of sub-1% as they are now. They do have the policy, so we should frankly be selling more bonds and spending the money on infrastructure, but hey, that's a hard story to sell for some reason.
It's not a favour, but then again, most favours aren't. "I owe you one" implies an expected mutually beneficial exchange.
It's a reliance on a (single) counter-party continuing to find the deal attractive. If, for whatever reason, they stop, the cost of debt will explode and bad things will happen. As you mention, it's a policy. Policies are subject to change. The Chinese economy is maturing into consuming more of its own output, and Chinese people are growing wealthier and more interested in buying foreign goods - both are long term trends that makes that policy less attractive.
The reason it's hard to sell that the existence of cheap debt as a signal to borrow and spend, is that the US isn't paying down its loans, it's rolling them over into new debt and assuming that the new debt is not significantly more expensive than the current.
That assumption need to hold several decades in the future. If it fails, things get real ugly.
EDIT: By "bad things" and "real ugly" I mean significant, sudden inflation which voters are unlikely to reward.
That's fair, and the commenters below pointed out that I was sort of conflating the short and long term yields on bonds, which dampens the enthusiasm for borrowing.
The thing is, right now, all of our borrowing is for things that don't pay much of an economic dividend, and meanwhile our infrastructure is going to absolute hell. If there was ever a time to borrow and spend some money on infrastructure, this is it. We can believe that while also believing the systemic budget problems need to be fixed.
> They do have the policy, so we should frankly be selling more bonds and spending the money on infrastructure, but hey, that's a hard story to sell for some reason.
Doesn't that put us at increased risk of the policy changing and then having that much more in bonds to roll over when the rates go back up? (Or are we are highly confident that the investment will pay off before the policy changes?)
That chart is for yields, which is distinct from rates. Although the rates for 30 year bonds are also greater than 3 percent (3.625 in the latest auction). However, if you are looking at inflation protected securities (TIPS) a 30 year TIPS bond has an interest rate of 0.625.
Please do not lump Social Security as part of the problem. That program is solvent. Your main point is correct, but maybe medicare is a better example since it is not a self sustaining program.
“Neither Medicare nor Social Security can sustain projected long-run programs in full under currently scheduled financing, and legislative changes are necessary to avoid disruptive consequences for beneficiaries and taxpayers.”
That's because Social Security has been running a surplus for many years (until 2010). The question is whether the US government, which already spent that surplus, but gave a bunch of bonds as promissory notes to repay, will actually do so. Payroll taxes were meant to prepare for the baby boom retirement, and were enough to do so, but that money is gone, not in a "lock box".
It's also been completely expected since the 1980s, so it's weird that this is now being portrayed as some kind of a problem. Reagan proposed an increase in payroll taxes, so that Social Security would run a large surplus for ~25 years, which would then fund the baby-boomer retirement. As far as cash-flow goes, that surplus went into the general treasury during the surplus years, and now it is the general treasury's obligation to repay it to Social Security out of general revenues for the next ~30-40 years.
It's possible people will choose not to do so, but that's not a matter of Social Security being insolvent. That's a matter of people simply not wanting to keep the promises, because they want lower taxes or something. If Social Security is not repaid, then payroll taxes will be retroactively converted to a regressive general income tax, where only income under $114k is taxed, which would be rather bad.
No, just euphemistic propaganda. The "disruptive consequences" are that within 20-30 years Social Security may have to be cut to what will be a higher benefit (if productivity gains are considered) than people are currently receiving now. The "legislative changes" are to cut benefits now.
Lumping Medicare in, which has a serious problem because of the horrible US healthcare system, allows Forbes to pretend as if there's anything wrong w/SS.
Looking at the whole article, the author is making the argument that the Chinese do not "invest" for monetary gain or loss, but rather use the Treasury purchases as a way to decrease their supply of dollars (a strategy necessary to keep their currency devalued, worth less than it would be if it were fairly traded without central bank intervention).
While it certainly is correct that a debtor at risk would have some concern for default, the point of the article is that (the author asserts) China doesn't particularly care for the stream of interest payments on it's bonds, or even the principal payment back at maturity, but rather the tool that the "investment vehicle" (Treasury) provides, it is China's most powerful weapon in sustaining its relatively devalued currency.
I don't fully understand the authors reasoning either but one thing that is highly misunderstood about the bonds is that a) they're not callable, meaning that borrowers can't suddenly decide that they want to get their investment back and b) China while the largest foreign national holder of US bonds (iirc) holds >10% of the issued bonds. Almost all bonds are held here in the US in things like mutual funds and by retail investors.
30% of treasury bonds are owned by the Fed, and in some recent auctions, the Fed has purchased as much as 90% of the new issuance. We would have a major problem if China were to dump their bonds on the market because there aren't too many buyers when you're at such low interest rates.
Why the downvote? I was responding to the claim the impact of a Chinese bond dump is "misunderstood" because most bonds are held in the US by retail investors and mutual funds.
In fact, most treasuries are not held by retail investors or mutual funds in the US [1]. The largest buyer as of late has been the Fed [2], indicating that when the Fed is pursuing ZIRP, there aren't a whole lot of other buyers. If China were to dump its bond portfolio, either interest rates would spike, or the Fed would have to expand its balance sheet by another trillion dollars.
>I have no formal background in economics, but I'd really appreciate it if someone who does could explain this statement in some context.
There is constant fear that someday China (and the rest of the world) will simply lose faith in the credit of the US and stop buying bonds. In the same way that you might decide CitiGroup is no longer a good investment, and stop buying (or selling) their bonds.
But in reality, it's not like the Chinese are looking around at all the sovereign debt in the world and deciding where to put their money. They have an excess of dollars from the sale of manufactured goods to go put to use. They could spend those dollars on American made products (and they do, to some degree), but the Chinese economy isn't quite in need of most of what we manufacture yet, and they have a lot of dollars to get rid of. So they buy US bonds. It's a mutually beneficial arrangement.
I'm glad some of this is reaching the mainstream media. I'm no expert myself, but this crisis, and the past few years have revealed that when it comes to the economy, we have a very misinformed, ignorant population.
The author is stating they don't do it because they believe the US is a good place (or not) to place their money (the usual criteria you would use when deciding amongst competing choices of where to put your money) They do it as a mechanism to achieve another goal: an artificially low value of their own currency. This is so their goods look cheap(er) to other countries. That in turn keeps employment high and social unrest low. That means less resistance to one party rule.
Characterizing it as a "favor" isn't helpful. It's more appropriate to say that there is more to the calculus than just the actual loan. Holding US debt has a direct benefit to China, but also an indirect benefit (it allows the U.S. to keep running huge trade deficits, which benefits Chinese manufacturing). If you look at just the return and risk on the debt, China's actions might not make sense, but if you look at the whole picture they do. At least, that's what the article is trying to get at.
If anyone thinks that anyone does anything as "a favour to the United States of America", they're deluded. The only reason China (or any other country for that matter) would do a favour like this for the U.S. is that it suits their own political agenda, whatever that may be. I'd be concerned that it's for less obvious reasons then artificially subsidizing their own exchange rate.
I think the author is making the point that the simple act of buying the bonds is accomplishing their goal.
They don't care what the return is, they just want to offload dollars. If you don't care about the return, then something is not an investment - the quality of the borrower (based on their ability/history of repayment) is moot.
>> I have no formal background in economics, but I'd really appreciate it if someone who does could explain this statement in some context.
Ignore the mainstream "Talking Heads" -economists in the media - they serve two main purposes: 1) Help Wall Street fleece unsuspecting "retail investors", and 2) Maintain the illusion that everything is alright.
Austrian Economics is right, and everything else is either wrong or meant to mislead you.
You see, you shouldn't be thinking naughty thoughts like: "Since I personally can't keep living beyond my means for ever and ever, why could any government? Don't the 'laws' of economics apply to governments?" (Hint: they do.)
Keynes is consistently proven to be far more accurate and effective than the Austrian school of thought. Keynes mets so much resistance because it's counter intuitive. Very literal thinkers have trouble with that and are attracted to the Austrian way of thinking.
>> Austrian economics has been exposed for its various faults in the academia, a modern decent education will reliably inform one of that.
.. And this is why I didn't bother with any arguments. I don't have all day to waste on arguing with misguided people.
But here's an idea: an economy consists of people making trades and investments etc. Each trade is affected by each person's current circumstances, ends, means and preferences, or even the mood he's in.
Did his wife die yesterday? Will that affect his behaviour in the market?
Now, the question is: How could you possibly model the behaviour of hundreds of millions of people in their daily lives with any kind of mathematical formulas when everything they do is subjective, and subject to their whims and moods?
Think about that.. and then think about whether Austrian economics has been "exposed" for anything.
Step-by-step, in plan English: (1) China sells stuff to US buyers, who pay with US dollars. (2) A US dollar is essentially a made-up financial instrument "backed by the full faith and credit" of the US -- it has value only because US laws make it so -- that is, by government fiat. (3) China could easily sell all those dollars, but if it did that, the dollar would depreciate, making Chinese products more expensive for US buyers! Chinese manufacturers would not like that. So what does China do with all those US dollars? (4) China buys US treasury bonds -- another made-up financial instrument, issued by the same government, that pays interest in the form of more dollars. Effectively, China exchanges one made-up instrument that pays no interest for another one that does. It's not an "investment" in the traditional sense of the word.
--
PS. If you find all of this mind-boggling, you're in good company. When asked about the value of money two centuries ago, Nathan Mayer Rothschild -- a member of the famous banking dynasty -- reportedly said that only two people in the world really understood it, but they disagreed with each other. And things were a lot simpler back then!
The way I see it its actually quite simple: the intrinsic value of X, anything from a piece of code to a building, needs a standard expression, and that expression is fiat currency. Currency has a value as long as someone is willing to trade something for it; the papiermark was worthless because nobody was willing to trade with it, the moment that happens with the US dollar it will become worthless as well.
The reason we use these standards is simple: convenience. We can discuss forever how many lines of code you would have to write to pay for your rent, and what if your landlord doesn't needs any code? then you have to find someone who needs code and is willing to trade it for something your landlord needs and its also equivalent to your rent. Fiat currency in this case is like the metric system: it works (nearly) everywhere.
It's strange you say it works because it happens that every case of hyperinflation in history has occurred under a fiat, paper system. Paper is very easy to debase, but if you want you can go to the "best" "schools" in the world and they can tell you why it's such a good idea... and maybe one day you can pick up a job at a central bank. And if you're really lucky your peers will prefix your name with a sobriquet of high honour as cool as "helicopter".
I'll give you a hint: it involves a pretty undistinguished metal from any practical standpoint that for some reason right wing nutjobs are totally obsessed with.
Sure. But gold, and diamonds and other pretty shiney things only have as much value as we place on them, the same as paper money.
@21echoes covers everything else I wold add on this.
The US currency used to be backed by gold up until 1934 [1], as did several other countries[2]. But as times have moved on, there are several other minerals which have become more important, I think it would become too difficult to rely on just a single precious metal these days.
> Sure. But gold, and diamonds and other pretty shiney things only have as much value as we place on them, the same as paper money.
Whenever I come across the argument that we return to a gold-backed economy, this is among one of the first things that comes to mind. Gold is worth so much because it's considered a precious metal and has numerous uses in industry. But besides the extensive history of its worth throughout the ages (which probably maps well to its chemical attributes, such as malleability), there's nothing that suggests it won't eventually become worthless if civilization values something else (salt, platinum, clean drinking water).
I used to think I was a little crazy whenever I'd have such an argument with my inner monologue, but now that I see the same point raised by others, I'm not so sure.
That's a very important case that is so fascinating because despite all the weaknesses of employing a precious metal as a currency; since the introduction of paper currency in the last centuries central bankers have managed to create hundreds more Spanish disasters in such small period of time!
Oh I'm sorry, you must inhabit that parallel universe where central bankers and their web of oligarchs are public-spirited socialists, and where in the words of Blankfein actually are "doing God's work".
Did it never strike you as odd that when the robber barrons were deposed by the class of disenfranchised oligarchs they were awarded the Federal Reserve as compensation.. Yes they were quite pleased.
Back to bartering? There have never been a big scale bartering system as they always end up being debt based since that is a lot more convenient for all parts.
6000 Years of Debt is a book that can be recommended for information about that. It is not a very good description of the present, but it captures the past very nicely.
I believe you mean "Debt: The First 5000 Years". I'm still reading it. It's good for understanding these ideas, but it spends a lot of time in the beginning in "the language of debt" and how it relates to religions. That is interesting in its own right, but not why I picked up the book.
yeah, that religious part was a bit far-fetched. (As a hindu/brahmin I LOL'd).
I've read several different theories of money and I don't find the debt vs coincidence-of-wants bifurcation that Graeber alludes to such a big difference in practice.
He pretty much hangs his whole approach off of that, but the two can be reconciled quite easily in my mind.
I wish everyone would read David Graeber (first) and then Detlev Schlichter.
Indirect exchange was not invented with paper pushing central bankers... Read some economic history, even a bad one and you'd know that already. Aside from French experiments with paper during their revolution, hyperinflation is very much a modern, paper induced phenomenon.
There are many, many problems involved in pinning your value system to a random, naturally occurring substance. See [1] for one argument.
Another obvious problem: if we pin our money supply on gold, what happens if we find an asteroid made up entirely of gold - enough to triple the quantity of gold on earth? The person who grabs that gold now owns the whole planet and the entire economy is ruined, even though no actual production has occurred.
As with democracy, paper money is the worst possible system except for every other system anybody has tried.
Notice that I haven't mentioned precious metals once, it's only been imputed by others including yourself.
Nevertheless if that's the road you want to go down then the impact on Spain from it's South American conquest is an example from history that somewhat parallels your asteroid of gold.
And yet where Spain's experience serves as a warning we have to look to the modern central bank and revolutionary France in order to gain a true glimpse of what unfolds when a single entity has in it's possession an asteroid of money. Paper money imposed imposed by fiat.
Subjectively in the opinion of many, gold fails in one aspect that is essential to a functional money in that it lacks what would generally considered a wide demand for "useful" applications. The subject value bestowed on it for being yellow and shiny is hardly considered a virtue but perhaps that says more about the human condition than gold? It does however satisfy the remaining requirements of a money very well. It's detractors in favour of paper should perhaps ask the same questions of their beloved wood pulp and see if it doesn't come up short.
The Atlantic article, is in my opinion weak and childish. I don't blame you for opinions, they are inevitable conclusions reached my the majority of bright minds educated by the system. Having been a successful CFA candidate I'm readily familiar with all the received "wisdom".
If there is one reason I would hope might persuade someone to reconsider the validity of the economic consensus if it would be the fact that I can assure you that if you do a little digging you will discover that the architects of the fiat, paper, fractional, central banking system; certainly agreed with me rather than you.
The reason today's system is so fragile is the their progeny have by and large bought into the economic snake oil that poured through education system to justify their monopoly.
I don't disagree with you at all - paper money is terrible. However, everything else is worse. The only better option is the complete removal of any kind of barter exchange - like a Star Trek economy - but that relies on a lack of scarcity and automation we haven't achieved yet. We are heading in the right direction fairly rapidly though - completely autonomous mines, factories and vehicles are one of the big turning points of the economy and we are very close to achieving that (50 years optimistically?).
rather than stating the risks/benefits of fiat vs metal-backed currencies as absolutes, how about you address them as they really are?
what would you rather have controlling your inflation/deflation rates? the rate of mining of a metal from the ground? or, in the case of the US dollar, a specialist committee controlled by a democratically elected government? (and don't come back to me with bullshit fed conspiracies, here).
i mean this question quite honestly: sometimes, your government is so fucked up that yes, indeed, the mining process, if less controllable, is at least more reliable. however, in the case of most modern, powerful countries, this is far from true.
You're post is incoherent. I'll try to address what I can.
You ask what I would have controlling inflation / deflation. The free market is my answer. Study the history of inflation / deflation you will see that almost without exception inflationary shocks are caused by the control of money and its supply by a narrow self-serving elite. You ask what else I would favour when a much better question would be why, based on the historical record you would ever lend intellectual support to the status quo.
You mention "bullshit Fed conspiracies". Do you actually understand the Fed and its origins? I'm 100% sure that you don't. The robber barrons were never deposed. When the Rockefellers and Morgans were relieve of thier "monopolies" they gained the greatest cartel and monopoly that one can possess: The power to print the money. The won the central bank. That's no conspiracy. It's fact.
Your mention of mining is a bit confused, and I don't really understand what your getting at. You are aware that mining isn't cost-free activity?
Finally, before you repeat the asinine arguments as a peasant shill of their cartel how about asking yourself why the central banks of the world retain gold as their most prized asset while at the same time quite successfully employing you, for free to peddle the notion that only toilet paper has any utility in internet discussions.
Your posts are so well-written that I feel compelled to point out these few errata while you may still edit this one post:
- Your post is incoherent.
- why, based on the historical record,
- were relieved of their
- They won the central
- what you're getting at
- , for free,
I actually pointed out the mistakes, then worried that the malformed sentences would remain, and so I've posted the corrections instead.
Also, I think you might be responding to a troll. Or at least somebody with no hope of understanding or redemption, which is almost worse. Sigh, such is HN on matters of inordinate privilege.
Reflecting on the problems with metals-backed currency (eg FRNs) it's a wonder that nobody thinks BTC is the ultimate form of money.
It's especially a wonder that us hackers don't think it'll work, and that HN is so opposed in general (at least judging by the number of comments against it).
I wonder if this reflects the US-centrism of HN. I believe it's become a lot more popular in Europe (especially Germany, where Satoshi may well have been from).
When asked about calculus three centuries ago, Isaac Newton reportedly said that only two people in the world really understood it, but they disagreed with each other.
The only thing I'd add here is this: when faced with spending more money than it has in the treasury, the U.S. has come upon a simple solution. Make up more imaginary money! More money for the Chinese, more money to build houses, more money for jobs. It's all good.
If there is any consensus among economists, which I doubt, my guess is that they would say that this is a good thing, except when too much imaginary money is created. Then the Chinese and other bond holders start asking for more interest, and the entire thing spins out of control. [Insert long argument here about when, exactly, that might happen or if it has already happened and we're just the walking dead right now]
Try explaining this to your grandmother. She'll think you've been smoking crack.
The Chinese government wants its citizens to be relatively poor. Why? because then it can use them as cheap labor that is a valuable tool to leverage on the world stage. Plus, poverty stifles political activism.
How does it keep its people poor? Well, by making sure a USD spent in China can buy 4x as much rice/milk/chicken/etc in China as it can in the US. This will mean income of Chinese workers and merchants will also remain low. How does it do this? By keeping the value of the yuan low, by direct manipulation of the currency, which it pays for by a high import tariff. (Which, again, makes Chinese people poorer by making things coming from outside the country very expensive.)
By using this strategy, the Chinese government uses its people as underpriced laborers that give it a huge export surplus and which it can use to influence world events, as well as to generate vast government capital (essentially capital it is withholding from its citizens) it can use to invest in foreign companies/governments.
(Of course now the picture is muddying somewhat because the extreme GDP growth is making many Chinese wealthy anyway, despite all these obstacles.)
I don't see it this way. The policy of cheap exports is actually to keep their people employed. Whatever they would be doing if they weren't exporting would keep them poorer than what they're doing today.
In addition, the large amount of foreign debt holdings gives them a claim on future output (or land, or other capital) of other countries. That gives the county geopolitical strength.
Do you have evidence to back that up? I can think of a number of examples to the contrary offhand: The French Revolution was preceded by a financial crisis and poverty, as was the rise of the Nazism in Germany. There's Mohamed Bouazizi, the poor and repressed fruit vendor who helped launch the Arab Spring in Tunisia. And even the Occupy and Tea Party movements that have each arisen in response to the economic situation within the US.
One of the interesting points I heard made in discussion of the Arab Spring is that it's not the poor but more privileged classes that generally spark revolutions. Here's the Wall Street Journal on the subject (I think I originally heard the idea on NPR):
While the poor struggle to survive from day to day, disappointed middle-class people are much more likely to engage in political activism to get their way.
This dynamic was evident in the Arab Spring, where regime-changing uprisings were led by tens of thousands of relatively well-educated young people. Both Tunisia and Egypt had produced large numbers of college graduates over the past generation. But the authoritarian governments of Zine El Abidine Ben Ali and Hosni Mubarak were classic crony-capitalist regimes, in which economic opportunities depended heavily on political connections. Neither country, in any event, had grown fast enough economically to provide jobs for ever-larger cohorts of young people. The result was political revolution.
None of this is a new phenomenon. The French, Bolshevik and Chinese Revolutions were all led by discontented middle-class individuals, even if their ultimate course was later affected by peasants, workers and the poor.
I think both Occupy and Tea Party movements fit this model. College kids mired in debt who can't find decent jobs. Aging white middle class conservatives watching the financial class run away with the lion's share of economic growth (while being led to believe that's it's being siphoned off by immigrants, welfare queens, and gay married couples).
Also brings to mind the old "Revolution to Conserve" idea I was introduced to back in AP American History:
It is simplified, but it is also wrong. If you're looking for a simplified explanation, the article doesn't do too bad a job. China has lifted over half a billion people out of poverty in the last 30 years. Dismissing that as a side effect of trying to "influence world events" is, frankly, preposterous.
Well, I think the Chinese people are the one who pulled themselves out of poverty, and they did this * in spite of * the government, not * because of * it.
>>By using this strategy, the Chinese government uses its people as underpriced laborers that give it a huge export surplus and which it can use to influence world events, as well as to generate vast government capital (essentially capital it is withholding from its citizens) it can use to invest in foreign companies/assets.
To what end? Let's say this is true, and let's also say that its strategy is successful. What is achieved if the end goal is not to better it's populace? And if it's goal is to better it's populace, why keep them down now at all and not immediately trying to improve the well-being of its citizens?
While i agree on the relatively poor part, i'm not so sure about this:
>>Plus, poverty stifles political activism.
It's very likely that the goalfor the Chinese government is to avoid being overthrown by keeping control on how much and how fast the citizen get richer.
Keeping them relatively poor guarantees that investments in future growth and future employment keep up rather than turning too soon into a more mature economy that keeps up with domestic demand.
And there's some kind of political argument about equality and history that i would make if only i could manage to sort it out in my head first.
It's not just China that has a lot of investment in US dollars - and no matter what the policy reason is, it is an investment because their wealth is tied up in the status of the US economy.
Now, our reserve currency status is something that China, along with the rest of the world, can lose faith in. And if they lose faith - because of, say, a default - then there's a serious risk that the US is no longer the reserve currency. And if the US is no longer the world's reserve currency, then a lot less other countries will buy US Treasury bonds, and US easy credit and privileged trade status will end.
I've not been following the connection between currency valuation and threat of default. I'm not sure if it's just my not seeing some connection (certainly possible) or others conflating things that aren't actually connected. Why should I expect less demand for my dollar a week after a US default?
US dollars are the world's currency hub. Let's pretend that there was only one airline hub in the country, and we're going to say that it's Atlanta, because I always seem to use that as my connection. (Atlanta is a hub, but it's not the hub.)
Let's also assume that you have to use the hub, no matter where you fly. It's easy to see in this scenario that Atlanta will now enjoy a special status as an airport; everyone has to use it, even if they're not sending passengers to Atlanta. Now, let's say that the Atlanta infrastructure starts doing poorly - the ground crews don't get luggage from plane to plane fast enough, the controllers aren't good at scheduling flights - anything we can think of that will cause delayed flights. If flights are delayed often enough, then Atlanta's value as a hub goes down. If Atlanta's value as a hub goes down enough, airlines may try to move to a hub somewhere else. Atlanta, then, no longer enjoys all of the perks that come with having every flight in the country routed through them.
This is a cartoon, of course. Nor is the analogy perfect. But I think it gets the big idea across: when people do international transactions, US dollars are often involved. Even when neither side of the transaction is actually in dollars. US dollars are the world's reserve currency: the US is a large, stable economy, and the main instrument for storing dollars, US Treasury bonds, is the most stable security around.
If US Treasury bonds cease to be the most stable security around, then we have violated a basic assumption of the global economy. The rest of the world may try to move away from the US dollar as the world's reserve currency, which means the US would no longer enjoy the special status of being the world's currency hub.
Adam Davidson (who does Planet Money, which I linked to above) has a NY Times column explaining that in the short term, investors may buy more Treasury bonds immediately after a default, but in the long term, we would still likely lose our reserve status. See, "Our Debt to Society": http://www.nytimes.com/2013/09/15/magazine/our-debt-to-socie...
Just to add an additional factor, related to stability but not identical: the size and liquidity of the bond market also matters. An advantage to U.S. Treasuries is that the total volume outstanding is extremely large, and they are frequently traded. Therefore even very large trades can be executed quite easily, without completely swamping the market. If you want to buy or sell $50 billion of U.S. Treasuries, that is quite possible.
Other countries that are considered safe government debt for retail investors typically have much smaller and less liquid bond markets, which would make them unsuitable as a place to park China-sized amounts of money. An attempt to buy or sell $50b of Canadian bonds, for example, would involve 10% of the entire outstanding issue (and about 200% of average daily trading volume).
That's one issue with the Euro becoming a reserve currency as well. The total size of the Eurozone is large enough, and the total value of Euro-denominated bonds is large enough, but the bond market is completely fragmented, since a unified Eurobond hasn't emerged. Instead, if you want to park a large amount of money in Eurozone government bonds, you have to trade in all these smaller markets: French bonds, Polish bonds, Finnish bonds, German bonds, Italian bonds, etc., each with a different risk and liquidity profile.
1). Interest and principle on USTs are paid in USD, so the notion that the Chinese government simply "wants to send those dollars back to the US" is bunk since they're ultimately getting more back
2). If the Chinese government wanted to directly influence USD value, they could also simply hold onto the USD as currency reserves to take it out of the market / reduce supply
By buying US debt, China is doing the same as the Fed: lowering yields/increasing prices of USTs via increased demand. This allows the government to keep borrowing large amounts, which in theory should offer the cash needed to continue buying Chinese goods.
Moreover, USTs are by far the most liquid high-grade paper available. Pretty much the only possible investment to support volume of the size China needs.
And, while not likely to be used in the near term, this is absolutely an investment in defense. Chinese officials have openly supported the notion that large holdings of Japanese debt could be used as a crippling weapon, why wouldn't that apply to the US?
>And, while not likely to be used in the near term, this is absolutely an investment in defense.
How? By dumping them below market rate? US/JPN will just print money and buy them.
If ever there is a war between these nations, these bonds become worthless overnight. Make no mistake, these T bonds are liabilities for China, not the other way around.
If the Chinese gov did that after loading up on gold, and backed the chinese currency with a fraction of gold, they would have a much better chance of convincing others to drop the US dollar as a reserve currency.
Yes, that was a popular theory around 1900 to 1914, when global trade as a part of global GDP reached a long term maxima that took a very long time to break (if it has been broken?).
I think that is really interesting because from what it seems based on events around the world, the economic interdependence between nation states has grown at the same time people within nation states economic realities are becoming more decoupled from that growth. From that decoupling, conflict emerges from which hasn't been seen before in the way that it is evolving now.
It's this context (China buying a ton of dollars to maintain their pegged value for the yuan) that completely destroys the Econ 101 theory that say the US should have massive inflation with our low interest rates and quantitative easement that's been happening.
That's why the various gold-standard fans and whoever have been saying "hyperinflation any day now" for the last 5 years and we're still rocking sub-1%.
One thing that I don't see mentioned often enough in discussions about China's US debt holdings is how much they actually hold. It's less than 10% of the total US debt, and about a quarter of all foreign-held debt. [1]
They are still the biggest foreign owner of US debt, but the majority of treasuries are owned by US entities (households, corporations, state and local governments, the social security trust, and government agencies that purchase treasuries when they have excess revenue). Of course I would count the Fed's massive holding of treasuries as separate from all of this, and there is plenty to worry about with our debt situation. My point is that China is far from "owning" the US.
>> It doesn't give China any leverage over the American government
They get some leverage. China's bond buying lowers rates on everything from mortgages to student loans. I agree that fear mongers overstate this, though.
>> the Chinese ... could order enormous quantities of Chipotle burritos and then throw them out. But that would be so hideously wasteful as to become politically untenable.
Even if it were tenable, it would still be a bad idea-- China want to suppress their currency now, but they're smart enough to know they may need to lift it later. That's why they buy US Bonds, similar to how the Fed buys or sells bonds depending on what effect it's going for. We've been in an extended period of buying so people forget that there are extended periods of selling, too. This gives them another tool apart from the usual raising interest rates, etc.
As an identity, the capital account between two countries -- payments made for capital: land, buildings, financial assets, etc. must equal the current account payments made for goods and services.
When we buy stuff from China, they get dollars. If you have a surplus of dollars you want to invest them in something, and that something has to be dollar denominated. Treasury bonds are safe, liquid and politically palatable for all sides.
If we stopped buying their stuff, they would stop buying our bonds. If they stopped buying our bonds, they would have to find somewhere else to invest dollars.
(Interesting side note -- this dilemma is what led to the creation of the Eurodollar market -- in the early 1970's the Soviet Union had dollars from oil sales (the international crude oil market is dollar denominated) and they did not want to put the money into US domiciled banks -- so the London banks said we will accept dollar deposits, but are not accountable to the Fed or other US authorities in these accounts (nor can we borrow at the Fed window) and thus was born the eurodollar.)
Today China in essence suppresses the standard of living of it's productive sector. They do this by not allowing the exporters to keep the dollars they earn. Instead the exporters are forced to trade those dollars in for Chinese currency which is artificially pegged against the dollar. This means the exporters immediately lose value.
What the author completely fails to understand is that this is another possible outcome:
* China decides to increase the standard of living of it's citizen
* China slowly increases their currency peg to be closer to the value of the dollar
* The exporters slowly have a higher profit, and thus the people a higher standard of living
* The united states slowly lowers it's standard of living
Of course this is one possible outcome. However, the idea that the Chinese are forced to buy our bonds is ridiculous.
They could just buy 1T in oil, copper, or other dollar based commodities. There are plenty of options besides treasuries.
> China slowly increases their currency peg to be closer to the value of the dollar -- The exporters slowly have a higher profit, and thus the people a higher standard of living
Exporters can't export if the price of their goods increase. It's not that easy to unroll their current scheme.
> They could just buy 1T in oil, copper, or other dollar based commodities. There are plenty of options besides treasuries.
How does one transport and store trillions of dollars of commodities (someone has to store them even if they are ETFs)? Besides, these commodities have a lot more risk compared to t-bonds. If the were able to get the same security as t-bonds in something else, you know they'd be buying those as well.
No, the chinese workers have a lesser standard of living because the suppressed value of the currency takes away from the value they can purchase with their wages.
It will even out in the long run as wage inflation will be impossible to fight while keeping down the value of the currency.
I think the outcome you outline is very well understood by the author.
He clearly says:
> This is Chinese industrial policy and it is conducted for domestic Chinese political reasons and will end some day for domestic Chinese political reasons.
It's a global economy. I take it you all agree on that.
I have a question for you: "With respect to importing and exporting, how important is it to be in balance, or to have trade surplus (versus a trade deficit)?"
China's strategy is aimed at ensuring it maintains a trade surplus. They have succeeded for centuries. China will export more than it imports.
And the US? Its strategy is to look for the cheapest labor and goods to "exploit", whereever those may be found.
What do you think? Which is the better strategy? Does trade balance matter?
As for this article, I have no idea what this guy is on about.
The US is primarily a buyer. China is primarily a seller.
If you accept that as true, then the US's "credit" is important. And who do you think decides whether a buyer's credit is good?
Would you keep shipping goods to a buyer who could not pay?
But the Chinese government for various reasons
wants to subsidize Chinese manufacturing. So they
want to send those dollars they accumulate back to
the United States.
China wants to send the dollars back to the US so that we can repeat the cycle. They could do it by buying US goods or stocks and the author explains why they don't. So the alternative is to buy treasuries.
I mostly agree, but they don't really have much of a choice. They have to put the dollars somewhere, and when you're dealing with that many, Treasury bills are really the only game in town.
China has about $1.2 trillion (with a 't') in Treasury bills. US GDP last year was about $15.7 trillion.
Bank of America has about $2 trillion in assets. If the amount of money you give to a bank is more than half its current assets, then your relationship to the bank is fundamentally different than anyone else. You're not a customer. You're an owner. That's the scale of money that we're talking here. Once you have this much money to store, it becomes clear that there's no such thing as a completely safe place. But, out of all of the unsafe places, US Treasury bills are less unsafe than everything else.
The author is very smart, and more trained in economics than I am, but I still disagree with some of what he says.
China is doing us two favors:
1) If they weren't buying our debt, someone else would. Without a large buyer like China, we would have to pay higher rates on our borrowing. This would trickle down to mortgages too, since China is a big investor in Fannie and Freddie debt, and mortgage backed securities.
2) Chinese goods are cheaper because of this policy. One could argue our domestic industry is less competitive, but on the surface, cheaper goods are better than more expensive goods. We benefit from the subsidy.
> 1) If they weren't buying our debt, someone else would. Without a large buyer like China, we would have to pay higher rates on our borrowing. This would trickle down to mortgages too, since China is a big investor in Fannie and Freddie debt, and mortgage backed securities.
The point is without the US dollar being propped up against the Chinese Yuan we wouldn't need to borrow as much because exports would be much higher (leading to more jobs, higher tax revenue, etc).
> 2) Chinese goods are cheaper because of this policy. One could argue our domestic industry is less competitive, but on the surface, cheaper goods are better than more expensive goods. We benefit from the subsidy.
Conversely, American goods are more expensive because of this policy. It's difficult to say if we benefit from the Chinese government subsidizing Chinese manufacturing. The price gap is beginning to close because of rising Chinese wages and US manufacturing is becoming more competitive (our wages are still markedly higher, but the shipping costs are much much lower), so it should be interesting to watch the next few years. Especially with the very low cost natural gas supply that's coming online in North America.
On point 1 - I agree with you in theory, in that anything we spend externally needs to be paid for by either selling something against it, or borrowing. This is Germany's issue too: they lend people money, so that others can buy their goods. My sense is that the Chinese aren't propping the currency up as much as they used to, but that's not based on hard data.
On 2 - In general countries (though not necessarily specific individuals and companies) do better with cheaper goods. This is why the gains of trade almost always exceed the costs. The question is does a forced cheapening by China create inefficiencies by moving us to tasks that we don't have competitive advantage? I don't know the answer.
Good discussion, and I appreciate your insights into economics.
It's at least as much about control. The Chinese don't want people to be able to push their currency around because they fear the destabilising effect of money surging in and out of the country and throwing the exchange rate around.
So they have massive dollar holdings in one hand and a central bank that can print money in another. Effectively they can control their exchange rate from either side.
> So what they choose to do instead is to purchase lots of US government debt.
Isn't "purchase debt" the same as "give a loan?" Is he saying China is not buying US T-Notes and Bonds? I don't understand how the US Treasury would not be liable for paying back the principal and interest on the bond. And not paying it back is the definition of a default.
The article argues that China is much less concerned about getting those payments than someone giving a loan would typically be (and thus much less likely to stop the practice if they don't get those payments) because they do it primarily to keep the exchange rate favorable for China's industry.
If country A (China) purchases the debt of country B (US of A) then "purchase debt" in that context is the same as B "issues a bond" which is the same as B "gives a loan". Yes. To the best of my knowledge, yes.
> I don't understand how the US Treasury would not be liable for paying back the principal and interest on the bond.
The US Treasury is liable, yes - but here is the catch that is never mentioned in any of these articles - at what rate? All these bonds are maturing at different times and have different rates of interest, right? So what would be helpful is that rather than saying that country B owes country A n trillion in total is if we were told how much per month (or year, or whatever) it is costing to service the loan - that would make it real. Note, IANAE.
They lack the delivery capability. They might have ~20? ICBMs and no SSBMs. They are very clearly determined to become a regional power rather than an intercontinental one.
when you owe too much, you become the one in absolute control, the loaner will pray for your good health before he goes to bed every night, that says it all.
I know a thing or two about economics, but I am far, far, far from calling myself an expert or even reasonably knowledgeable. With that prelude, can someone explain this:
If China is getting lots of dollars from selling goods to the US, and then buying lots of US Bonds to keep those dollars out of the Chinese economy, presumably the bonds are just being held somewhere. They represent a promise from the US to China that says "Those goods you sold us? We haven't really paid for them yet, but at some point in the future we will, with a bit of interest."
So at this point the goods have changed hands, the Chinese workers have been paid in Yuan, and the Chinese government is holding the excess USD value of those goods in a big pile of paper.
What happens if the US says to China "You know what? We're not going to be paying you for those goods afterall. Sorry about that."
Obviously, this will piss off China, but let's ignore the political ramifications. What are the economic consequences? The pile of paper is now worthless, so the net worth of the Chinese government drops. Does that matter? The dollars aren't part of the Chinese economy, so there shouldn't be an impact there. Is the Chinese government using their US Bond portfolio as an asset to back borrowing from other countries? Is it counting on the interest to fund future spending? (Risky gamble if they are.)
Going forward, the Chinese probably won't be so willing to buy more US Bonds, which would be understandable, and other countries and individuals might be wary as well. But maybe not, if it's framed as a one-time reset of our debt (kind of like a bankruptcy) and there's some changes to the way our debt is managed to make sure it doesn't get out of control again. (Maybe an amendment to hold all living US politicians, past and present, personally accountable for a proportion of the US debt weighted by the height and duration of their office.)
So, maybe we could still sell bonds, and maybe not. If the Chinese stop buying, they're going to have to come up with another way to keep USD out of their economy if they want to continue selling goods to the US. That makes me think they'll keep buying the bonds, especially if there's no material impact from writing off the value of the existing bonds. Or maybe they'll buy other things from us. They want a navy, and we've got a bunch of ships mothballed in various states of disrepair and a need to earn revenue without selling bonds, so maybe a deal can be struck there. It's got to be cheaper to cleanup and retrofit an old ship than building a new one from scratch, even if it's less impressive. They can use the old ones for support ships or something.
Here in the US, I don't think we'd be likely to see fewer Chinese goods coming in or their prices raised, because both of those would be detrimental to the Chinese. We'd definitely have to get government spending under control because we couldn't sell so many bonds (if any), but we need to do that anyway. Zeroing out a big chunk of the existing debt will eliminate a lot of interest payments, which would help a lot.
So, does the reluctance to do this all come down to the reputation of the US Government and the US People's ability to pay back the debt we've accumulated?
The issue is that the global diet for treasuries artificially holds down interest rates. If purchases slowed or holdings were sold, interest rates would rise. Whether it would be a crisis or merely hurt is a marginal distinction.
The government of the USA would go bankrupt in months if interest rates rose to 5%, which is an historically normal figure.
There's nothing artificial about it. That's normal economics at work.
Interest rates will remain low as long as the economy remains weak. They will rise to 5% when the economy becomes stronger and inflation rises, reducing the level of existing debt to GDP.
That would be worse for China because the value of CNY would skyrocket stopping their exports. Value of USD would plummet helping US exports.
Besides, China and foreigners are not anywhere near the biggest buyers of US debt. Fed is. Chinese and Japanese had actually five month net selling period earlier this year.
It would be a crisis so long as China remains an export-driven manufacturing-based economy. But, as China becomes wealthier, knowledge-based economy, it won't be as big a deal. With 1/6th of the world's population, I would think there would be plenty of domestic buyers.
It's rather tricky to predict how a Chinese decision to appreciate the rmb would play out in practice. Many export powerhouses have had very strong currencies for long periods. It's not as simple as saying US exports would go up and the Chinese economy would suffer. You have to consider that the Chinese have savings and would find themselves far richer in global commodities. You also have to consider the US economy's heavy dependence on freakishly low interest rates.
I have no formal background in economics, but I'd really appreciate it if someone who does could explain this statement in some context.
I would have thought as a general rule: a debtor at risk (even theoretical risk) of default constitutes a concern to its creditor.
I also don't see what giving favours has to do with buying and selling bonds.