Most of the economists and pundits who could not see an $8 trillion housing bubble are telling us that the United States desperately needs for the Chinese government to keep buying its debt. This crew of failed analysts argues that without the support of the Chinese government, interest rates in the United States will rise, choking off the recovery. In reality, the decision by China to stop buying U.S. government debt may not harm the economy's recovery, but it could be devastating to the recovery efforts at Citigroup and other basket case banks.
The basic logic is simple. China's central bank has been buying up huge amounts of dollar-based assets for the last decade. Their purchases include short and long-term government debt, mortgage backed securities and to a lesser extent private assets.
The Chinese central bank's purchases have two effects. First, they help to keep interest rates low. This supports economic growth by keeping down the interest rate on mortgages, car loans and other borrowing that boosts demand.
The other effect of China's purchase of dollar-based assets is that it keeps down the value of its currency against the dollar. This is the famed currency "manipulation," that draws frequent complaints from politicians. Of course, it is not exactly manipulation. China has an explicit policy of keeping down the value of its currency against the dollar. It is not buying up hundreds of billions of dollars of U.S. assets in the dark of night. It does it in broad daylight in order to keep its currency at the targeted rate.
Suppose China stopped buying up U.S. government debt. Interest rates in the U.S. would rise, which would have some negative impact on growth. Of course, the Fed could try to offset this rise in rates by simply buying more debt itself. It has already been buying debt and it could simply buy enough to replace the lost demand from China. This would leave interest rates largely unchanged.
Suppose that the Fed doesn't intervene and lets interest rates rise. This will have some negative impact on growth, but there will also be a very positive side from China's decision to stop buying dollars. The dollar would fall in value against China's currency. This would make Chinese goods more expensive in the United States, leading U.S. consumers to purchases fewer imports from China and more domestically produced goods.
A lower-valued dollar would also make our exports cheaper in China. That would allow us to export more to China.
The net effect would be an improvement in our trade balance, bringing back some of the 5.5 million jobs that we've lost in manufacturing over the last decade. In fact, since nearly all economists agree that the current trade deficit can't persist for long, China would be helping the country bring about a necessary adjustment if it stopped buying up dollars.
Even the rise in interest rates would have a positive effect since it would allow for the completion of the deflation of the housing bubble, with house prices finally settling back to their trend levels. This drop in house prices will be a painful adjustment, but there is no way to avoid it. Bubbles cannot be sustained indefinitely and we are better off allowing the housing market to return to normal so we can get back to a path of sustainable growth.
While decision of the Chinese to stop buying dollars might be good for the economy, it is likely to be disastrous for Citigroup and the rest of the basket case banks. If interest rates rose, then the value of the government bonds they hold would plummet. If the interest rate on 10-year Treasury bonds goes from the current 3.5 percent to a still low 4.5 percent, then the banks will have lost 8 percent on their holdings. At a 5.5 percent interest rate, a rate that would still be far below the average for the 90s, the loss would be 15 percent. Citi and the other basket cases could not endure these losses in their current financial state.
This could be why we see shrill pronouncements from the likes of the Washington Post editors, and other "experts" who couldn't see an $8 trillion housing bubble, that we need the Chinese government to keep buying up our debt. We absolutely do not need the Chinese government to keep buying U.S. debt and would almost certainly be better off if it stopped tomorrow. Citigroup and the other big banks do need the Chinese government to keep the money flowing if they are to have a chance of getting back on their feet. And, we know where the sympathies of the Washington Post's editors and other "experts" lie.
Dave Johnson: Palin vs. Krugman on the Dollar -- Who Is Right?
A falling, or "weak," dollar is great for American manufacturers. Conservatives, though, are trying to use the complexities of the relative value of the dollar in currency markets as an anti-Obama political issue.
What's the downside of that?
The US has the singular problem - and blessing - of printing the world's reserve currency. You really can't take that out of the equation when speaking of the dollar's value, as this author does. We're not talking about the British Pound or the Swedish Crown. Reserve currency status does mean a too high currency - and with it, medium-term loss of manufacturing jobs. But it also contains the short-term temptation of being able to spend more - much more - than one earns. In the long run, the US would probably be better off if the dollar was replaced on global markets by a basket of currencies. But how many politicians are there who would propose the corresponding short-term sacrifice to their electorates? My guess is, the US will do what it can to maintain its reserve currency privileges - and China, Japan and the oil countries will do what they can to help, anxious as they are to avoid the devaluation of their foreign reserves. But someday this balloon, too, will burst.
For ever and ever, amen. Or, may the Lord help us. To stand on our own two feet.
It is patently absurd to aver that "nation-X must continue doing something just to benefit nation-Y." Especially if in the same breath you continue, "... because nation-Y is incapable of doing so for itself."
So sorry you royally screwed-up your banking-business. And Senator/Representative whoever-you-are, I guess you've been taking bribes from the wrong goon. So sorry. So sorry. So sorry. Ahem.
No, as a matter of fact, the United States of America does NOT need Communist China to, how do you say it, "prop it up."
For how many years have Americans had it drilled into their heads that the United States, pinnacle of the market system, is also the extreme point of economic efficiency? Everyday, tens of millions of Americans jump into their cars and go speeding off to work. In their spare time, it's off to the malls--well, not as much these days. Americans are not efficient users of this particular resource, but the US simply is not efficient, broadly speaking.
The US will have to learn how to be more efficient in real terms--playing make pretend will no longer be acceptable. It seems reasonable to accept the hard truth that America can no longer live on the cheap, and that it will have to honor its trading partners' goods with higher prices.
http://www.warresisters.org/pages/piechart.htm
There is oil in the US too. It is just expensive to extract from the ground. When oil prices are high, it pays to extract oil from the US soil. That is why the Bush administrations wanted high oil prices so their Texas oil buddies could rake in the big bucks (to the detriment of the rest of the country). If oil prices went up, production in the US would go up. The problem is the oil companies just sell to the open market so only a very tiny few in Texas benefit (unless there's some sort of oil tax like in Alaska-but then all the hair on the backs of the right wingers goes up).