China’s Warning Shot?
Posted by The Diatribe Guy on February 25, 2010
Evidence is mounting that Chinese sales of US Treasury bonds over recent months are intended as a warning shot to Washington over escalating political disputes rather than being part of a routine portfolio shift as thought at first.
Use of China’s $2.4 trillion reserves to challenge US foreign policy is fraught with problems, not least because any damage to America will recoils immediately against China – which depends on the US market for its mercantilist growth strategy. Beijing cannot stop accumulating dollars unless it is willing to let the yuan ride, eroding the margins of its export industry. Some reserves can be parked in gold or even copper, but liquid commodity markets are not big enough to absorb the scale of Chinese surpluses.
China and America are locked together by fate. Any petulant action by either side involves a degree of `mutual assured destruction’. But sometimes in politics – as in life – emotion flies out of control.
Some discussion notes on this:
Zero Hedge is covering a lot of information on this issue.
The dollar’s value is really tied to this debt. China is in a position to manipulate the value of the dollar by strengthening or weakening their holdings. This is because a release of these bonds forces the United States to find another buyer. If that buyer is not there, then absent fiscal responsibility in Washington, then one alternative is to print money, which devalues the dollar. Another alternative is to attract a buyer by increasing interest rates. But because so much of our debt is short-term debt, an increase in interest rates will cause debt service to skyrocket. Absent fiscal discipline in Washington, this requires more lending and/or money creation. When one holder of our bonds is in a position to create these sorts of problems, they own us. When two holders have the potential to coordinate actions to crush us (Japan is now the largest debt-holder) it is a recipe for concern.
China pegs its currency to a basket of currencies. They have problems of their own. And they will devalue their currency to protect exports if they consider that in their best interest. But make no mistake… the day could come when China makes a determination that they can afford to see the U.S. crash, and that it may in fact be in their best interest for that to happen, even if there are short-term issues on their end. China is not all about economics. They will be willing to hurt themselves economically if ideology or other considerations outweight that.
The U.S. could alleviate this problem by installing some very harsh – but necessary – fiscal discipline. And it’s not about more revenue, it’s about less spending. That won’t happen, but one can hope.
The more China spreads its interests around the world and diversifies away from the U.S., the more they are able to withstand an implosion in the U.S. China is reaching out globally. Not just Europe – which has its own problems – but in Africa as well.
Some believe that the Chinese are only sabre-rattling, and are in no position to do anything to endanger their position with the U.S. Some things of note here are (1) demographic issues spawned by the 1-child policy: too many males, too severe a ratio in elderly to young people, etc.; (2) political corruption; (3) environmental issues they’ll need to deal with, similar to many issues all developing countries deal with as they grow; (4) overall poor relations with neighbors (distrust, hate, fear…); (5) the India factor – a very large population and resource that could be tapped instead of China, if needed. These all point to China needing to rely on the assistance of other nations, or suggests they require some sort of friendship or standing in the world community.
I don’t buy that completely, though I see the point. China doesn’t think like the rest of the world. The one-child policy alone shows that. They will take dramatic measures (dare I say evil ones) if needed to correct demographic problems. They can and will do that on their own. And political corrpution? Nothing new, and certainly not unique to China. Environmental issues can be rectified there, just as they have been rectified here. You grow into those things. I honestly don’t think China cares about its standing in the eyes of the world community except as a means to an end. If other interests dominate, they don’t care what anyone else thinks. And as for India, I think China simply believes that they can pretty much do what they want, and there will always be countries willing to use their services. And they’re probably right.
The largest issue China has to deal with is trying to balance its antipathy towards Islam with the need for relations with the oil-producing Islamic countries.
We need China more than they need us. Sad, but true. We’re backed into a pretty uncomfortable corner.