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.
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.
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
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.
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.
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.
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.
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.)
Go forth and educate thyself: http://mises.org
( Oh, and ignore all the clueless pontificators on HN too )
--
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 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.
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.
Or more specifically, because US taxes must be paid in dollars, and dollars must be used to buy US financial instruments.
Unfortunately, most of HN doesn't seem to. Moldbuggery is a good introduction.
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.)
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.
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.
http://online.wsj.com/news/articles/SB1000142412788732387390...
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:
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?
>>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.
Planet Money podcast, "Why The World Still Needs Dollars": http://www.npr.org/blogs/money/2011/08/12/139583229/the-frid...
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...
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?
http://www.telegraph.co.uk/finance/china-business/9551727/Be...
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.
How do you go broke? Slowly, then all at once.
http://web.mit.edu/~sabrevln/Public/GameTheory/Journal%20of%...
Then came a set of World Wars.
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%.
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.
[1] http://www.treasury.gov/resource-center/data-chart-center/ti...
>> 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.
Own a million to the bank, and it will dictate your life.
Own a billion to the bank, and you will dictate their life.
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.)
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.
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.
It will even out in the long run as wage inflation will be impossible to fight while keeping down the value of the currency.
> This is Chinese industrial policy and it is conducted for domestic Chinese political reasons and will end some day for domestic Chinese political reasons.
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?
Ridiculous, simply untrue.
Currency manipulation explains the conversion from yuan to dollars, but not from dollars to t-bills.
Why would China convert dollars to t-bills if they didn't see t-bills as a better investment than dollars?
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.
Also, Sal Khan has this video on the topic: https://www.khanacademy.org/economics-finance-domain/core-fi...
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.
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 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.
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.
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.
> 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.
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 government of the USA would go bankrupt in months if interest rates rose to 5%, which is an historically normal figure.
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.