

Why China Needs U.S. Debt - DanielBMarkham
http://www.realclearworld.com/articles/2009/02/why_china_needs_us_debt.html

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Eliezer
China produces more than it consumes and ships the excess to the US. This
keeps its economy roaring, but we don't send them back other goods or
services. Instead we send them US debt. The Chinese value this sufficiently
that they stay in a productive mood and keep on producing, and their economy
keeps growing. It's sort of like inflation except that instead of everyone in
China having more and more printed Chinese money, everyone has more and more
US debt.

Am I the only one who thinks something is deeply, fundamentally _deranged_
over here? If the global economy were a computer program, it would be time to
throw out the old code and redesign everything from scratch.

~~~
mattmaroon
I have always wondered about this. They essentially improve their country by
financing our buying. Why don't they simply buy directly? Could they not
instead put that excess money into building things they desperately need, like
roads and schools?

Investing in a first world infrastructure would stimulate growth at home and
lessen their reliance on our consumers (whose buying habits have recently
become rather fickle) and our Treasury. The second part may be more important
too, with our country hurling toward a Social Security meltdown. Our debt as a
percentage of GDP might be low now (relative to Japan) but check back in 20
years.

I'm not an economist, but I'd love to hear from some why I'm wrong (which I'll
assume I am).

~~~
jganetsk
The simple answer is, they don't have a choice.

Some number of dollars flow into their country every year. Some number of
dollars flow out. The difference effectively ends up in the hands of the
government. They have to do something with it... because if they do nothing
with it, they are effectively exchanging Chinese goods for nothing more than
cheaply printed pieces of paper.

They government can't spend US dollars inside of China. The only thing they
could do is buy American exports, and American assets.

If China were somehow to launch a stimulus plan that was fueled by American
production, than that would have the effect you are suggesting. They could
have Americans come over and build their roads and schools for them, with
American materials. They would improve their infrastructure and we would get
our money back. But this is impractical, and China gets the long-term
benefits, not us. In fact, we get screwed in the long-term, because the return
of all those dollars to America would cause inflation.

~~~
mattmaroon
That's silly. They could certainly spend them in China. Many people there
would happily accept US dollars. That's why they have so many of them in the
first place, business selling products to Americans. And there are always ways
to exchange.

All investing them does is get them even more US dollars. If the problem is
that they can't spend US dollars in China, how does using those US dollars to
collect more US dollars help at all?

~~~
jganetsk
The reason any government would want to build a foreign currency reserve, as
I've stated in another post, is to help mitigate a currency crisis. In the
case the Renminbi has a large drop in value, they would start pumping dollars
in and pumping Renminbi out. By decreasing the supply of Renminbi, and giving
folks a supposedly more stable currency to hold onto, they can fix a currency
problem.

If the Bank of China were to spend US dollars domestically, it would be
exactly equivalent to printing Renminbi and spending it. It would be just like
a stimulus plan. There's nothing different. Remember, Bank of China must print
all the Renminbi necessary to keep the exchange rate at the peg. So watch
this:

1\. Chinese government spends 100 million USD for public works project 2\.
Businesses receive 100 million USD, want to convert it to CNY, bring it to
USD-CNY exchange market 3\. Government prints CNY to soak up 100 million USD

We are right back to where we started, except now there is more CNY in
circulation.

Now if we relax the assumption in step 2 that businesses want to convert to
USD upfront, we still have the same problem, because it just delays the
conversion. While USD is in circulation, there will be some converted to CNY
at every transaction (for wages and taxes and things like that).

If the government wanted to enact a stimulus plan, and I think they already
did, then they should just do it in CNY.

Note: China does not maintain a strict CNY-USD peg. CNY is pegged to a basket
of currency.

------
1gor
China has been keeping the value of its own currency down in order to support
its exports to the US, and in the process it has been accumulating dollars
(which then are invested in US debt). There is a big question if they will
continue to do that.

The US debt accumulation process runs like this.

A Chinese exporter of electric goods (for example) has its revenues in US
dollars but his costs are mostly in Yuan. As he receives money from his
American customers, he sells dollars to buy local currency to pay his workers,
to pay taxes etc. Without Chinese central bank intervention the collective
activity of exporters would drive Yuan rate up vs dollar very quickly and that
would make their exports less competitive.

Chinese central bank wants to keep exports competitive, so it buys US dollars
from the exporters at artificially high rates. Its 'foreign currency reserves'
keep growing as long as there are exporters bringing in piles of export
revenues in dollars. All these dollars needs to be bought up in order to keep
Chinese exports competitive. And then all these bought dollars need to be
invested, the US Treasuries being the natural place for it.

This all works as long as US consumer is buying. But the US consumers have
stopped buying like they used to for many years and some say forever. No major
revenues are expected from exports to the US. No need to buy dollars for the
Central Bank.

In fact, the opposite is likely to happen. Chinese domestic consumption is
growing fast. Very soon domestic Chinese market will become the biggest target
for the world's exporters, just as US post-war consumer was. Chinese central
bank may want to stimulate local consumption and capital inflows by switching
to 'strong Yuan' policy, just like US did with its dollar. There will be no
point of spporting the USD and holding dollar-denominated securities (US
treasuries) for them.

To summarize, Chinese investment in US treasuries is not a result of desire to
find a 'safe heaven' for extra money. It is because they need to park all that
greenbacks the accumulated during years of keeping the Yuan down. Today they
do not need to support USD anymore. They have no reason to buy US debt either.
Prepare for a nasty surprise.

------
mattchew
Yes, of course, let us in the U.S. keep telling ourselves that China (and
Japan) have _no other option_ but to keep extending us ever increasing amounts
of debt. Our credit is _safe_ , it is rated AAA, there are no other outlets, a
U.S. debt crisis would be a seventeen sigma event, blah blah blah.

It all sounds familiar, somehow.

~~~
jganetsk
The AAA credit rating is in terms of US dollars. It would make no sense for
the Fed to not have an AAA credit rating.

~~~
gravitycop
_The AAA credit rating is in terms of US dollars._

Sometimes. Sometimes not. <http://en.wikipedia.org/wiki/Credit_rating>

<http://en.wikipedia.org/wiki/Equivocation_fallacy>

~~~
vlad
_Sometimes. Sometimes not._

The Credit Rating wikipedia page does not show him to be wrong. Also, the
fallacy linked to is not applicable. Would you care to elaborate?

~~~
gravitycop
_The Credit Rating wikipedia page does not show him to be wrong._

Was linking to the Credit Rating wikipedia page intended to show someone to be
wrong? The Credit Rating wikipedia page indicates that _credit rating_ can be
defined in more than one way.

 _Would you care to elaborate?_

Do you know what _equivocation_ is?

------
robbyb03
Stop letting the Chinese buy American dollars, which would cause their
currency to increase in value, by stopping deficit spending, thus stop
allowing them to buy our debt and keep their currency artificially low.

Start paying off the debt that China currently holds and take American dollars
off of the market, which would cause their currency to increase in value
because of the peg. Continue this policy with other countries that peg their
currency to the American dollar as well.

Enact the FairTax which would allow corporations to produce goods and services
here with a 0% corporate tax rate instead of importing those goods into the
United States.

Increase tariffs on countries who peg their currency to the American dollar,
to produce and export goods cheaper, so that the United States can have the
competitive advantage, with corporations, on the global market thus creating
goods and services here.

------
patrickg-zill
Two things you can do with US debt:

1\. Buy precious metals such as gold and silver and then take physical
delivery - COMEX is required to accept US debt as an equivalent to cash. This
would raise the price of silver significantly - you can just about corner the
market for silver with about $5B to $6B. Buying even a fraction of the gold
that China has stated they wish to acquire would send the gold price soaring.

2\. Buy other assets such as real estate, commodities like copper, aluminum,
steel, wheat, chicken legs, etc. Competing with Americans and Europeans for
some of these commodities would also drive the price up.

Bottom line: inflation is coming to America and possibly Europe (which may be
in better shape) as well.

~~~
teyc
sooner or later, China would have to bring trade back into equilibrium. The
purpose of debt is to have it repaid one day. This can only be when Chinese
are willing to pay for U.S. goods. This can be either when both countries
enjoy some kind of parity.

This is not as far fetched as it sounds. The savings rate of Chinese Gen X'ers
are 0. They are voracious consumers. If Chinese goverment decided to fund
local debt instead of foreign debt, U.S. manufacturing could conceivably come
back and sell into China in the future.

