'Cause I Said So…

Our China Problem: One Option

Posted in China, Free Trade, Government, Government Debt, International by kevinsoberg on March 9, 2010

Before I even get started, let’s get something clear. We must get our fiscal house in order. To do this we must get our budget deficits to a manageable level and on a downward trajectory. If we have any hope of changing direction, we have to cut federal expenditures, which means only one thing, reducing transfers of wealth: the so-called “entitlements,” and the funding of state and local governments. This definitely means no expansion of the welfare state through additional programs, such as increased federal involvement in health care.

That being said, we all know: You’re only truly concerned about your credit score or keeping your creditors happy when you’re planning on borrowing more money. So, we need to put that out of our head. We cannot borrow our way back to economic health. It’s what’s gotten us into this situation in the first, second and third places. So, playing “nice” with China is the last thing about which we should worry.

It drives me up the wall every time I hear some supposed “wise man” tell us how China has us over a barrel due to the vast quantities of U.S. Government debt they hold. According to them, American influence and actions around the world are constrained because one country, a competitor on the world stage, holds our mortgage. Is this international emasculation really the case? Why don’t we break this argument down?

1)  China is a competitor for world power. You’re kidding me, right? A country whose GDP is one-third of ours (measured in exchange-rate terms) is a threat to us? Remember, China’s national income is spread among 1.3 billion people. Do the math. It means each of their “citizens” generates about one-twelfth the income as do each of ours. So yeah, they have a lot of people, but each one produces very little value. It would be like fearing Ukraine, El Salvador, or Egypt.

2)  China has the largest population in the world. Yes, they do have a lot of people, and due to that large, poor population, they long ago instituted a one child policy. This population control policy has had the desired effect, and there are now less young people than old. The average age of the Chinese is following the path of Europe’s. Before the end of the century, China’s population will be in decline and will bear the costs of an aging people.

3)  China’s is a huge trading partner with America. Export-based economies are built on one of two things: commodities or labor “efficiency.” In China’s case, they have leveraged their low labor costs and economies of scale to build an oversized industrial base. In doing so, they have made the same mistake Japan and others have made before them. They have failed to create a domestic consumer market sufficient to maintain their economy in the down times of the international business cycle. Neither the size of nor the poverty of your population will guarantee an indefinite advantage based solely upon labor costs, as opposed to productivity. Someone is always poorer than you are.

4)  Trade between the U.S. and China is lopsided in China’s favor. A major disadvantage of export-based economies is large, recurring current account “surpluses.” Gee, haven’t we always heard that’s a great thing? Isn’t it terrible that we’ve been running these current account “deficits” for decades now? No. In reality, there are no deficits or surpluses. The money must ultimately go somewhere, and that somewhere is the home country. “Surpluses” must be spent in the originating country, or else you’re sitting on a virtually worthless stack of paper, which by the way is loosing value due to both inflation and time-value.

As an example, let’s say I trade with Bob, who only pays me in “Bob dollars” for the things he buys. Ultimately, I have to buy stuff from Bob, or from someone else who does, to realize my value for the items I’ve sold. If not, what am I going to do with these “Bob dollars”? Like Monopoly money, it’s worthless outside its context. Now, those things could be “Bob things,” “Bob stock” or “Bob debt.” Regardless, Bob’s getting his money, his value, returned to him. As long as Bob controls the trading currency, Bob cannot really lose.

5) China should be buying consumable items to even our trade imbalance. Money invested in any vehicle puts liquidity into our markets. No matter where it’s invested, it has a positive effect by freeing up capital from other areas of the economy. It actually keeps interest rates down by lessening competition for available capital. If that money were spent on consumables, it could actually raise costs to consumers by increasing demand.

6)  We can’t have foreigners buying up U.S. investments and properties. Why not? What are they going to do with them? They’re only worth what they are because they’re where they are. They can’t take it with them. How much influence can these purchases have? This is a sovereign nation. There are 300 million people here. It’s not like we’ll let someone run roughshod over us because of some property ownership. Remember what happened to Japan? Everyone was all worried about them in the ‘80’s and ‘90’s. Anyone worried now?

7)  It’s dangerous for China to hold so much U.S. Government debt. How so? Is it because they’ll influence decision makers worried about a big sell off of their stake? If so, then it sounds like more of a problem with our politicians. Any elected official who worries about China’s holdings should be sent home. If they’ve authorized so much debt that their decisions can be affected by just one country, they were not thinking long-term and were acting foolishly. U.S. interests are, or should be, the first priority of any public official. To behave otherwise is tantamount to treason.

8)  What happens if China decides to make an aggressive move financially? First, any major dump of U.S. treasuries will have an adverse effect on the remainder of China’s holdings. Second, this will cause a devaluation in others’ holdings as well. Third, it will dry up the market for our debt. Fourth, the current government will continue to spend, in effect printing money, which will cause a devaluation of the dollar and a dramatic increase in inflation. Fifth, in an attempt to salvage worth, foreign investors will dump all dollar denominated securities thereby driving all markets further down. Rosy scenario, huh?

So, how can we prevent China from negatively affecting our politics and our economy? That’s easy. Let it be known, in no uncertain terms, that we will not allow such a thing to occur. We would view any such behavior as an act of war. We need to make an official statement, something similar to this:

A notice to the Republic of China – In the event of sale, by your government, your citizens and/ or your agents, of greater than 5% of your current United States Treasury holdings in one month’s time, the following actions will result:

A.  We shall disregard all sales in excess of that allotment. We shall not recognize the transaction(s) as having occurred. The unfortunate purchaser(s) shall not receive interest payments nor be allowed to redeem the debt;

B.  We shall cease to recognize the remaining United States debt held by the Republic of China, its citizens and its agents. The debt shall no longer be redeemable, nor shall interest be paid on it;

C.  All diplomats, personnel, and other citizens of the Republic of China shall be expelled from the United States within 24 hours. Any person remaining unlawfully in the United States shall be considered an illegal alien combatant;

D.  Any third-party who attempts to arbitrage unrecognized debt in an attempt to have it redeemed shall be treated as a criminal, subject to United States’ law, and risks causing non-recognition of their nation’s and their fellow citizen’s holdings;

E.  Any public and/ or private holdings, in the United States, its territories and on the high seas, of the Republic of China, its citizens or its agents shall be subject to immediate seizure;

F.  Any attempt by a nation or individual to aid the Republic of China, its agents or its citizens against the United States shall be treated as an act of war;

G.  Any and all United States Treasury debt legitimately held by non-aggressor nations, their citizens and their agents shall be fully recognized by the United States.

The beauty of this proposal is that it gives a very stern warning to those who need it, but if used it punishes only the guilty. China and its people have every right to divest themselves of U.S. government debt, if that is their wish. They may do so in a slow even manner, in quantities the market can absorb. What they don’t have is the right to destabilize (or to threaten to destabilize) the U.S. economy by playing geo-political games with our sovereign debt. If we allowed any country to endanger us, we would be foolhardy at best, suicidal at worst.

Ideally, we want trade with everyone who sees it as mutually beneficial. Also, we should not exclude anyone from any of our markets when they have capital to invest. However, these markets exist for investment purposes only. They are not to be used as tools against us. That message should be made loud and clear.

One Response

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  1. Stickeenotes said, on April 11, 2010 at 10:52 pm

    I like the way you think.

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