Apparently, Secretary Geithner is going to China this weekend. In part, he’s going to be there to tell China to stop exporting so much.
Which, of course, raises a serious question. If China stops exporting (as much) to the US, where will they get the dollars to lend our government so that we can repair our crumbling roads and bridges?
The rather obvious effect: we’re going to have to get the money some other way.
For example, the Fed could just print the money and buy the Treasuries.
Some other interesting points:
(1) Peter Schiff predicted “decoupling”. I confess that I doubted this idea. Then, it started happening… and now the US’s Sec. of the Treasury is explicitly asking for it.
(2) As someone who is irrationally optimistic, I have held the belief that Bernanke wouldn’t allow a hyperinflation. That is, he would actually reverse course when inflation looked like it would be a problem. Given this new evidence, it’s obvious that Mark Thornton and Jeff Tucker (and others) are dead right. Bernanke’s choice isn’t just between hyperinflation and “somewhat higher” interest rates. It’s going to be between hyperinflation and soaring interest rates. It’s hard to believe that he’ll tolerate soaring interest rates – even if he would have tolerated “somewhat higher” rates.
Which really leaves the Fed with one halfway decent option. Increase reserve requirements.
But I’m finding it more difficult to be irrationally optimistic about that actually occurring…
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Oh, the policy cross-purposes. It never ceases to amaze.
Might you be underestimating China’s reliance on the US? I think so.
Forgetting its dollar holdings momentarily, China relies on the US for an array of its own imported goods including: food, recyclable commodities, machinery, building products and more.
China is terribly stuck in having to negatively leverage its currency to the dollar, sterilize those currency inflows buying low yield treasuries, and then purchase goods from the US in dollars of decreasing value.
Most have yet to wake up to the possibility that China is perhaps 7 to 10 times more leveraged than the US – both monetarily and leveraged to future growth of per capita GDP.
What the heck? What’s his motive? I smell BS
R Gardnr – Might you be confusing China’s reliance on trade in real goods with the US (stuff for stuff) with the illusory benefits it supposedly gets by trading real things for accumulating dollar debt?
Instead of having the government print RMB to buy dollars that it will only spend later (undoubtedly the #1 cause of inflation here in China), why not let importers cut out the middleman (China’s central bank), buy dollars from their fellow exporters, and change the dollars for real things almost immediately?
Wouldn’t that make China’s people better off, rather than its gov’t holding onto massive amounts of dollars which are sure to decline precipitously in value in the years to come?
I love this. The Keynesian Treasury Secretary is going to China to tell them to stop accepting our increasingly worthless currency.
Isn’t this the Utopia Keynes wanted? The US gets its stuff from China who does all the work and the US gets to improve itself in the arts and other uninteresting things.
My only comment is that the US Citizenry better pray that Obama and his minions are completely unsuccessful at this and that the US and China remain economically intertwined. The old saying always applies: If goods don’t cross borders then armies will.
I think that R Gardnr is onto something.
The Chinese are dealing with the aftermath of an enormous bubble. Much of the so-called news which trickles out of China has been about layoffs, unemployment and halted construction projects lately. Like the United Stated in the 1920′s, genuine economic growth and its accompanying downward pressure on prices masked a large growth in the Chinese money supply, the consequences of which are only now being revealed.
China’s government policy is, at best, marginally free market. Among other things, the Chinese government maintains an enormous military, is undertaking massive public-works projects, prohibits couples from having more than one child and is committed to paying pensions to large portions of the Chinese public.
Most importantly, the Chinese government believes firmly in the old mercantilism. It is determined to build its export sector and secure access to foreign raw materials. To do this, is has expanded the Chinese money supply in tandem with the growth in the U.S. money supply, extending loans to the U.S. for the purchase of Chinese goods.
If, at some point, the Chinese government attempts to sell off some of its U.S. treasuries, it is likely to be doing so in an attempt halt a slide in the value of the yuan. Selling of it’s stock of US bonds would spell disaster for the Chinese government’s beloved export sector. In fact, any slowdown in Chinese purchases of US debt will expose malinvestment in China’s export sector. Therefore, the Chinese will continue buying treasuries.
Mr. Engelhardt asks, “If China stops exporting (as much) to the US, where will they get the dollars to lend our government so that we can repair our crumbling roads and bridges?”
U.S. treasuries are traded on the market, and the Chinese government can buy any amount without asking anyone for permission. The Chinese government does not want to stop buying U.S. bonds. Chinese purchases of dollars and dollar denominated assets have no immediate effect on the size of the U.S. money supply.
If our government attempts to prevent the Chinese from buying treasuries, the Chinese will buy dollars instead. However, our government will not do this, because it would be difficult and unpopular. Whatever policy our government chooses, the Chinese must continue to buy U.S. base money to maintain its exports to the U.S.
Talk of “decoupling” is mere bluster. The only thing which will bring Chinese lending to a halt is massive price inflation in China.
Ben Ransom and R Gardnr,
My “argument” is very brief.
(1) Total exports from the US to China in 4th Quarter 2008: $20 billion. Total capital flows from China to the US: $100 billion. Who is more dependent on whom should be clear enough.
(2) If China wants to buy US Treasuries, they don’t have to get permission. But, they do have to get dollars. As long as they’re exporting to the US, the dollars flow to them that way. If they stop, it’s not clear how they can get dollars without disrupting their exchange rate. It seems to be your argument that they simply won’t stop exporting so much to the US. That may or may not be true.
My point is just that, if they do what Geithner asks (and some of their economic plans suggest that they are at least trying to move that direction), it’s going to make selling US Treasuries to China more difficult as they won’t have the dollars with which to buy them.
As far as decoupling – I trust that you haven’t seen the latest trade figures. In March, the US’s Trade Volume was down 30% from its peak just 8 months before. Since trade volume is falling far faster than GDP, it would seem to follow that economies are in fact becoming less “coupled”.
Mr. Engelhardt,
The relationship between the U.S. and China, as far as interference with the money supply is concerned, is not one of dependence. The Federal Reserve controls the supply of dollars. The People’s Bank of China controls the supply of yuan.
When the Chinese experiment with mercantilism ends, the losers will be the Chinese. The Chinese are exporting real goods and paying for them by creating new money.
The People’s Bank of China, like other central banks issuing fiat money, is not particularly worried about a rise in the value of the currency it issues. The decision by the Chinese to use new money to subsidize exporters is guided by a belief in mercantilism. It resembles our own government’s desire for newly created dollars to flow into the housing market.
It would be for the best if China stopped inflating. This would expose malinvestment in the Chinese export sector. But the Chinese government does not want to deal with a bust in its export sector any more than our own government wants to deal with a bust in real estate. This is why the Chinese are continuing to inflate, and steering the money into the export sector.
The Chinese government can maintain this policy as long as it can create the money necessary to make exporting goods (which would not otherwise be exported) to the US profitable. The ultimate check on this policy will be price inflation in China, just as the ultimate check on the attempt by the U.S. to reflate the housing bubble will be price inflation in the U.S.
It is true that the trade gap, as measured in dollars, has declined. However, skepticism of aggregates is always justified, and prices have been extremely volatile lately. Though the trade gap has shrunk, its continuance indicates that the Chinese government is continuing to steer new money into exports.
I think it is unlikely that the Chinese government is going to stop printing yuan and face the music.
Ben Ranson,
I kind of feel like we probably fundamentally agree on most of this but are talking past each other a lot – mostly because I’m focusing on the pains that will come to the US during the adjustment process while you’re focusing on the pains to the Chinese.
For example, I see very little in what you wrote that I disagree with. China has been printing money like mad, and has been encouraging (mal)investment in the export-oriented sector. Abandoning the export-oriented policies will entail a painful adjustment process, as it really isn’t quite so simple as the Chinese just buying their own stuff. (It is unlikely that the mix of goods that the Chinese public would buy from itself is identical to what the US currently buys, so resources have to be reallocated.)
However, there will also be a painful adjustment process for the US, as stopping purchases from China will mean a couple things. First, it means we’ll have to adjust our consumption and production patterns, as we won’t be able to rely on (artificially) cheap Chinese imports. Second, it means we’ll have to save more of our own money so that the government can borrow it – or, as is happening, we’re going to have to print the money to fund the government’s spending. This will entail further adjustments – or maladjustments, as the case may be.
Just a point of clarification: I was discussing trade volume. That is, exports + imports, both as positive numbers. This is different from the “trade gap” or “trade deficit/surplus”. The fact is that both imports and exports have fallen substantially, so that not only the trade gap has narrowed, but trade volume has fallen. This simply means that the US is trading less with other countries than before – and is actually importing less and exporting less. True, data can always be a problem. But, for the 30% nominal fall to be illusory, it would have to be the case that the “average” relevant import and export prices fell by 30% – which seems quite far fetched to me. I strongly suspect that there are, in fact, significantly fewer goods crossing borders now than there were a year ago.
Mr. Engelhardt,
You were discussing trade volume. I stand corrected.
When the Chinese government abandons its current policies, they adjustment process will be significantly more painful for the Chinese people than for the American people. As you point out, Americans will no longer be “able to rely on (artificially) cheap Chinese imports.”
While Americans only lose a subsidy, the Chinese will have to acknowledge the fact that the massive debt owed to them by the American government will never be repaid in full. However, this realization will not necessarily be instantaneous.
I do not agree entirely with your second point, as far as the Chinese are concerned. “Second, it means we’ll have to save more of our own money so that the government can borrow it – or, as is happening, we’re going to have to print the money to fund the government’s spending.”
The American government is committed to a policy of inflation regardless for the behavior of the Chinese. The two factors which are driving our current American inflation are our government’s large deficit and the Fed’s purchases of all varieties of paper in its effort to save insolvent banks.
These American policies will lead to disaster no matter what the Chinese do. It is possible that China’s purchase of treasuries is significantly delaying this day of reckoning. I doubt that this delay is significant. All people acquainted with our government’s financial situation and the size of China’s holdings of treasuries understand that this debt can never be paid off.
The Chinese government’s rash purchases of treasuries will eventually end. When this occurs, the Fed might or might not have to deal with an immediate increased influx of treasuries into our banking system. If it occurs, this influx may take the form of a Chinese sell-off of bonds, larger purchases of bonds by American banks as the Chinese stop buying bonds, or both.
The Fed could deal with this in a number of ways. It could print money. It could increase reserve requirements. It could allow banks to fail. It could embark on a propaganda campaign to encourage the public to buy bonds.
It is possible that such an influx will not occur, or will occur slowly, even in the event of a Chinese sell-off of treasuries.
A factor which I believe is often neglected is the likelihood of a collapse in the value of the yuan. This event would probably cause the Chinese government to begin selling its treasuries in an effort to soak up yuan. The Federal Reserve does not have significant holdings of yuan; most yuan are held by the Chinese public. Therefore, these bonds will be sold to the Chinese public. If the Chinese public re-sell these bonds to get cash, the cash will be in the form of dollars. This process, in the near term, will serve to prevent an increase in the American monetary base.
Because China is not a free market country, and because the Chinese people are not allowed to trade freely in dollars, our knowledge of the Chinese public’s demand for dollars, treasuries and dollar denominated assets is limited. I think it is safe to assume that the Chinese public regards dollar denominated assets as secure.
If the yuan collapses in value, the Chinese government will not be able to sell its stock of treasuries without relaxing restrictions on the Chinese public’s trade in dollars and dollar denominated assets. It is possible that, in such a situation, many Chinese people would attempt to move their savings to the safety of dollar denominated assets. This might, at least temporarily drive the value of the dollar up.
Of course, in the long term, the dollar will lose value as the Fed monetizes our debt.
P.S. A collapse in the value of the yuan would likely also be accompanied by the flight of foreign capital out of China. This would also tend to push up the value of the dollar in the short term.
Ben – What, exactly, will cause the value of the Yuan to collapse? Based on current policy, the only way that could happen is if its central bank keeps printing Yuan to buy dollars.
If they stop doing that, the value of the Yuan will go up.
Even assuming its central bank decided to sell bonds for Yuan to China’s people, it’s unlikely that China’s people would hold treasury bonds instead of using them to get real assets or commodities. Especially if present spending by the gov’t and base money creation by the Federal Reserve continue.
That means rising interest rates and prices of everything in America.
You’re absolutely right that there would need to be a reallocation of resources in China as the malinvestment in China’s exporting industry was revealed. However, China’s production capability would remain about the same in real terms (so long as the gov’t didn’t step in to prevent massive bankruptcies, and it hasn’t so far here in southern China) and you can hardly say the same for America’s consumption capability as demand for treasuries dries up.
Jeremy,
The yuan would be expected to fall in value as the Chinese government creates new money.
This can happen even if the Chinese central bank does not use the new yuan to buy treasuries. New yuan can also be spent in China in any number of ways. For example, the new money could be spent on China’s stimulus package. In general, it is the creation of new yuan which diminishes the value of the yuan, not the manner in which the new money is spent.
The decision by the Chinese to inflate, and the subsidisation of exports to the U.S. are different policies. These policies can be followed independentantly of one another.
I agree that “it’s unlikely that China’s people would hold treasury bonds instead of using them to get real assets or commodities.” But, I believe that many of the assets purchased by Chinese and foreign investors abandoning the yuan would likely be in the United States. Dollars in American bank accounts would probably be the most desired commodity.
This could, for a short time, drive the value of the dollar up.
Hi Ben – I agree that it is the creation of Yuan which drives its value down, but for now (or at least up till now), much of the RMB the Chinese government prints is used to buy dollars.
I don’t understand how holding some of the dollars Chinese people got by selling treasuries would drive the value of the dollar up. Let’s assume Chinese people keep half of the US money they get from the gov’t in exchange for Yuan, either in the form of treasuries or deposit accounts after selling the treasuries. That means that they are still spending half of China’s reserves. They aren’t buying any new treasuries, and any dollars they get would only be had by driving interest rates up (selling off of treasuries).
The half of the money they would spend or invest in real assets (non-US dollar assets) would have already driven interest rates up (when they sold half the treasuries on hand) and prices up (when they spent the dollars).
Unless you’re assuming that at the same time the Chinese government is selling trillions of dollars of treasuries to Chinese people its people also make even more purchases of dollars overseas? Otherwise how could at least some selling of treasuries and spending of dollars not drive interest rates and prices up?
Jeremy,
Chinese sales of treasuries would, to some degree, raise the value of the yuan against the dollar. There are many other elements in play which can affect the exchange rate. Focus on the size of China’s stockpile of treasuries is misleading, and makes the yuan appear stronger than it really is.
The reason that China initially began purchasing treasuries was the same reason that so many other countries issuing fiat money want to hold treasuries. The treasuries form a reserve which, while not officially backing the currency, can be sold when necessary to raise the price of the currency being issued.
In the eyes of the public, and of most central bankers, treasuries are a secure investment. Central bankers, in general, do not believe that their sales of treasuries, in times of crises, will drive down the price of treasuries to a point where treasuries become ineffective as a reserve. This is because demand for treasuries by the public during market crashes has historically been strong.
The event that is most likely to trigger Chinese sales of treasuries is a sudden fall in the value of the yuan. I believe that it is important to consider all the likely causes and consequences of such an event and then judge the possibilities for changes in the exchange rate.
One element initially pointed out by Mr. Engelhardt is that, if the Chinese buy fewer bonds, or begin selling bonds, it might be necessary for the Fed to increase reserve requirements for American banks. This is because American inflation is typically driven by sales of treasuries by banks to the Fed. The money from these sales is credited to the bank’s accounts at the Fed, and forms the base for American monetary expansion.
The demand by holders of yuan (the Chinese public and foreign investors in China) for dollars and treasuries could have a significant mediating effect on an increase in the American monetary base in an event of a Chinese sell-off of treasuries. It is important to remember that a sell-off is likely to be triggered by a fall in the yuan. (And accompanied by an increase in demand for treasuries as investors pull money out of Chinese investments.)
Chinese sales of treasuries need not be accompanied by a reduction in the supply of yuan. The revenue from these sales could be spent immediately by the Chinese government, and thus return directly to circulation. Indeed, Chinese sales of treasuries could be accompanied by continued growth in the supply of yuan. This could be accomplished by printing new yuan as the stockpile of treasuries is sold.
There are also other factors, such as the U.S. and Chinese gold reserves, which we have not even begin to analyze.
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