A few thoughts about China and their bluff on treasuries
Marshall Auerback here.
Here is my take on Chinese Premier Wen’s recent statements. At the end of the day, too many people seem to be working on an old gold standard type of model in the sense that there are implied limits in terms of what the US can do as an issuer of a fiat currency. I have always seen this as relevant only to the extent that China insists on being paid back in another currency other than dollars. The irony is too wonderful here, for what China has become expert at is manipulating the Obama administration. Think from the Chinese perspective about the wonders of getting Secetary Clinton to grovel and thank them for buying our paper.
The Chinese, in recent closed door meetings of which I am aware, have openly (albeit implicitly) threatened U.S. government officials about their future willingness to purchase our agency debt. This is a grand bluff, for China would suffer the greatest loss of (paper) wealth were it to attack the value of our paper. It is proving an effective bluff. I never thought Geithner’s attack on China’s efforts to hold down the exchange rate on the yuan made any sense from a U.S. perspective, so I don’t waste my time bashing the administration on its 180 degree reversal of position on China “manipulating” the yuan. But we are being played successfully. China will conclude that they have leverage over us and will use it in future disputes that will be far more important.
In a pure operational sense, when China’s US securities mature, the Fed debits their securities account at the Fed and credits their bank account at the Fed. So in theory no fuss. Of course, the real world is a bit more complicated, even when a sovereign currency is assumed (i.e. fixed exchange rate, no fixed gold conversion).
The limit to trade deficits is then the willingness of foreign investors to net save in your currency.
If foreigners perceive your productivity capacity is not growing fast enough, or the money value of those products is not growing fast enough, the only reason they net save in your currency (by holding assets in your currency) is to speculate on asset bubbles or engage in financial engineering or store value in the perceived reserve currency of the world.
Remember, foreign trading partners can demand settlement from a country in a different currency. There is a first mover disadvantage to exporters trying to enforce this, but we have seen currency conventions change, so we know it does happen. And I am presuming this is the implied threat from China.
All 3 of the above (asset bubbles, financial engineering, reserve currency status), one would think, are eventually constrained by the first two items, physical productivity of the country and the money value of that output. We’ve seen in a world of serial asset bubbles, with no country yet willing or able to replace the US as hegemon, that “eventually” can take a long time. Not every hegemon, however, can hold on to its “exorbitant privilege” for so long…and there is only one hegemon, so not every country has this privilege.
Similarly, a fiscal deficit is constrained by the willingness of the domestic and foreign private sector to net save in the deficit country currency. The private income is created by the purchases of products or labor from the private sector, so there is still production.
This circles back to our discussions about confidence and policy sequencing. Keynes, who was a policy maker and an investor, clearly recognized this and it is part of why he spilled so much ink against the Treasury View of fiscal responsibility. He wanted to change conventional views of the suitable role of government intervention. It is currently Obama’s practical problem, as he does not seem to feel the need or ability to address the Treasury View. Instead, he has taken the tack that he will promise to reduce the deficit by the end of his term.
A lot of staunch Keynesians probably believe that Obama’s problem goes away once the fiscal stimulus hits the real economy. Practically, we know investors here and abroad are skeptical of how this all gets financed (a non-issue in our friend Warren Mosler‘s model – government credits private sector as deficit spending proceed), and entrepreneurs and the wealthy are beginning to figure out the tax burden is being shifted on to them. So that might induce capital flight and tax evasion, which isn’t something readily accounted for in a classic financial balances approach.
Reality is more complicated than the model, and that must be dealt with by practical policy makers.
“At the end of the day, too many people seem to be working on an old gold standard type of model in the sense that there are implied limits in terms of what the US can do as an issuer of a fiat currency.”
I do not believe this to be true. We got in this mess because there was nothing equivalent to the gold standard to keep the monetary expansion and government growth from getting out of hand.
“The irony is too wonderful here, for what China has become expert at is manipulating the Obama administration. Think from the Chinese perspective about the wonders of getting Secetary Clinton to grovel and thank them for buying our paper.”
If the drunk cannot pay his tab and wants more drinks he will grovel to the bar owner. The simple fact is that China is the biggest holder of US debt and can choose not to buy any more. While monetization by the Fed would clearly reduce the value of Chinese UST holdings the Chinese would benefit if they can get in on the reserve currency game.
“The Chinese, in recent closed door meetings of which I am aware, have openly (albeit implicitly) threatened U.S. government officials about their future willingness to purchase our agency debt. This is a grand bluff, for China would suffer the greatest loss of (paper) wealth were it to attack the value of our paper.”
You are missing reality here. The US benefits from being able to buy real goods by printing money. The loss of the reserve currency status for the USD would make the US the equivalent of 1920s England.
“China will conclude that they have leverage over us and will use it in future disputes that will be far more important.”
As your biggest creditor China does have leverage. If you want that leverage to go away you need to stop spending more than you make and start saving and accumulating productive capital.
“In a pure operational sense, when China’s US securities mature, the Fed debits their securities account at the Fed and credits their bank account at the Fed. So in theory no fuss. Of course, the real world is a bit more complicated, even when a sovereign currency is assumed (i.e. fixed exchange rate, no fixed gold conversion).”
The Chinese have a choice. They can hedge their exposure by picking up shares of large companies with real assets and massive debt exposure. They can purchase long dated commodity futures contracts. They can purchase physical gold. With each step they become less vulnerable but put the US in a worse position.
“The limit to trade deficits is then the willingness of foreign investors to net save in your currency.”
But why save the currency? If Americans can no longer bid up the price of real goods the Chinese can afford to purchase much more of what they make. One way to postpone the effects of a post-Peak Oil world is to force the world’s biggest consumer nation to use much less of it. One way to deal with a food crisis is to have the world’s biggest purchaser of food have to cut back.
“If foreigners perceive your productivity capacity is not growing fast enough, or the money value of those products is not growing fast enough, the only reason they net save in your currency (by holding assets in your currency) is to speculate on asset bubbles or engage in financial engineering or store value in the perceived reserve currency of the world.”
Well, private investors are not buying the USD and USTs. If they want to speculate there are many other ways to do so rather than take the risks that come with holding the debt of a bankrupt nation that will have to print money.
“Remember, foreign trading partners can demand settlement from a country in a different currency. There is a first mover disadvantage to exporters trying to enforce this, but we have seen currency conventions change, so we know it does happen. And I am presuming this is the implied threat from China.”
That is exactly what it appears to be. The Chinese are trying to convince OPEC and its commodity suppliers to start thinking about using currencies other than the USD for settlement purposes.
“We’ve seen in a world of serial asset bubbles, with no country yet willing or able to replace the US as hegemon, that “eventually” can take a long time. Not every hegemon, however, can hold on to its “exorbitant privilege” for so long…and there is only one hegemon, so not every country has this privilege.”
The fact remains that the US has massive problems with productivity and spending. Unfunded liabilities stand over $100 trillion once we include such off balance sheet items as SS and Medicare and there is no way to use taxes to make good on those liabilities. The Chinese see this and are taking steps to hedge their positions.
“The private income is created by the purchases of products or labor from the private sector, so there is still production.”
Sadly, American production is collapsing in real terms and much of the economy was focused on sectors that are in big trouble. That means that private income will be contracting and that deficits will grow as the tax base collapses.
“This circles back to our discussions about confidence and policy sequencing. Keynes, who was a policy maker and an investor, clearly recognized this and it is part of why he spilled so much ink against the Treasury View of fiscal responsibility. He wanted to change conventional views of the suitable role of government intervention. It is currently Obama’s practical problem, as he does not seem to feel the need or ability to address the Treasury View. Instead, he has taken the tack that he will promise to reduce the deficit by the end of his term.”
First, Keynes lost credibility a very long time ago when history showed his theories were just as intellectually bankrupt as individuals found when they took the time to read him carefully and critically. Second, if the crisis is to end something more substantial is required than confidence. Sadly, Obama is as insubstantial as his predecessor.
“A lot of staunch Keynesians probably believe that Obama’s problem goes away once the fiscal stimulus hits the real economy. Practically, we know investors here and abroad are skeptical of how this all gets financed (a non-issue in Mosler’s model – government credits private sector as deficit spending proceed), and entrepreneurs and the wealthy are beginning to figure out the tax burden is being shifted on to them. So that might induce capital flight and tax evasion, which isn’t something readily accounted for in a classic financial balances approach.”
Do I detect confusion? If taxes go up you can be certain that evasion and capital flight will reduce the tax revenues. When Hoover and FDR hiked taxes on the rich all they did was turn a sharp contraction into a Great Depression. Bernake and Obama seem to have chosen a similar approach.
“Reality is more complicated than the model, and that must be dealt with by practical policy makers.”
Actually, reality cannot be modelled by economists because the economy is too complex and entirely non-linear. That said, sound economic principles tell us exactly what must be done to get us out of trouble; cut government spending and reduce the tax burden on workers and investors. The path that should be taken is the once chosen by Harding, not Hoover/FDR.