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  • Will China Sell?

    Will China Sell?

    Place your bets: The temporal rationality of Congress vs the ruthless rationality of the Chinese government.

    We all knew it would come to this eventually. Over the years as the goods made in China piled up in U.S. homes and a mountain of U.S. agency and treasury paper piled up in China, the following idea was proposed by nine out of ten economists with no accountability for their theories, and accepted as expedient truth by U.S. economic policy makers: China will never be so foolish as to sell U.S. Treasury Bonds and crash the U.S. economy, the main source of demand for its goods, and the U.S. Congress will not be idiotic enough to impose trade sanctions on China to force China to devalue its currency and, as a consequence, slow the torrid growth of the Chinese economy, upon which the Chinese government depends to maintain political legitimacy. (Note: Two items comprise the entire list of deliverables that maintain an unelected government in power: domestic economic success or heavy handed domestic repression.)

    As we mentioned over a year ago in Economic M.A.D., miscalculation is not rare in international affairs, and is especially likely when the calculations are being made by people who have a well established track record for error.

    There is little in the past behavior of the Chinese government to encourage the belief that it will initiate a mutually destructive economic exchange with the U.S. The Chinese government is nothing if not ruthlessly rational. Instances of Congress behaving irrationally and self-destructively, on the other hand, are legion.

    Most famously in the area of economically devastating legislation, the signing into law of the populist Smoot-Hawley Tariff Act in June 17, 1930. While proving politicians responsive to the will of millions of unemployed voters the law helped turn a bad recession into The Great Depression. At the time, nine out of ten economists warned of this result, but Congress wasn't listening. Economists warned that it would invite retaliation by European powers. The unpopular Hoover signed the tariff into law anyway, perhaps hoping to score a few political points. Turned out the economists were right that time and that the European threat of retaliation was no joke. We doubt the Chinese are joking, either.

    More recently, Congress stood by as a massive housing bubble developed. As we enter the inevitable collapse-and-hearings stage that marks one of the final stages of a bubble, the extent of Congressional economic know-how is revealed. Not easy to watch on a full stomach.



    Video Created by Friend of iTulip john67elco on YouTube

    Apparently, the Chinese are worried that Congress will behave like Congress, and are making an effort to instill some rationality.
    China threatens 'nuclear option' of dollar sales
    August 7, 2007 (Telegraph - Ambrose Evans-Pritchard)

    The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

    Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (658bn) of foreign reserves as a political weapon to counter pressure from the US Congress. Shifts in Chinese policy are often announced through key think tanks and academies.

    Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels.It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession. It is estimated that China holds over $900bn in a mix of US bonds.
    On the U.S. side of the table, we have the political think tankers taking the position that the problem is China's policy of maintaining an artificially undervalued exchange rate. The advice is music to your congress-person's ears, because it means they can avoid the more politically difficult question of why their constituents are unable to save enough income to fund the government via taxation and why thus the U.S. is out hat-in-hand borrowing from China in the first place.
    A Slow-Moving Chinese Train Wreck
    August 7, 2007 (American Enterprise Institute)

    As U.S. Treasury Secretary Hank Paulson ends yet another round of Strategic Economic Dialogue talks in Beijing with very little progress to show for his efforts, one cannot help feeling that one is watching a slowly unfolding Greek tragedy. For all the main protagonists of this drama play their parts seemingly oblivious to the very unhappy end towards which their actions are inexorably leading them. And they certainly pay no heed to the growing chorus of Cassandras warning of the grave dangers to the global trade system that lie ahead.

    Among the leading protagonists in this drama are Chinese President Hu Jinato and Vice Premier Wu Yi, who represent the Chinese Communist Party in these talks. Filled with hubris, they never seem to tire of reminding Mr. Paulson of China's 5,000-year glorious imperial past. Nor do they tire of making it quite clear that a country of China's historic importance is not about to change its exchange rate policy under pressure from the United States, a relative newcomer on the international stage. Rather, they insist that the Chinese government will set its exchange rate policy exclusively in China's own national economic interest.

    The Chinese also make it quite clear by their actions, if not by their words, that they view China's economic interest as that of maintaining an artificially undervalued exchange rate. They do so with a view to allowing China's exports to grow each year by a staggering 30 percent, which they see as the only realistic way that the Chinese economy can absorb the 10 million workers who leave the Chinese countryside for the cities each year.
    The question of "who is right," is academic. The questions are, Will Congress push the plunger? And if it does, will China sell?

    If Congress does anything to significantly damage China's economy, and this the domestic political position of the Chinese government, you can count on it. They will have to, just as the Europeans did in the 1930s. That is the unforgiving logic of the economic and political relationship between the U.S. and China. What is not known is the strength or fragility of the Chinese government in the eyes of its population, and whether a seemingly minor political move by the U.S. might precipitate an economic and then a political crisis there.

    Will Congress push the plunger? Can they behave that irrationally and self-destructively?

    It's an election year. Anything is possible.

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    Last edited by FRED; 08-10-07, 09:55 AM.

  • #2
    Re: Will China Sell?

    Originally posted by EJ View Post
    Will China Sell?

    Will Congress pull the trigger? Can they behave that irrationally and self-destructively?

    It's an election year. Anything is possible.
    Yes. I believe Congress will pull the trigger. Oddly enough, just when you think you're not getting representation by your government, they're going to crack down on the Chinese as a result of the pain and suffering their constituents are feeling; a transference of "please do something." That "something" will be to punish the Chinese without realizing, even if told of the consequences, that those consequences will be to punish themselves.

    Like Aykroyd in Ghostbusters when told to choose his destroyer, he said he thought of the most harmless creature he could imagine from his childhood, the Staypuft Marshmallow Man. Boom, in walks the 100ft version of your dream.

    Yes. They have before and they will again. They are a representation of the stupid herd.

    Not only possible, but likely.
    Last edited by Uncle Jack; 08-07-07, 07:10 PM. Reason: spelling and remove image from the quote
    It's all fun and games until someone loses an eye!

    Comment


    • #3
      Re: Will China Sell?

      Originally posted by Uncle Jack View Post
      Yes. I believe Congress will pull the trigger. Oddly enough, just when you think you're not getting representation by your government, they're going to crack down on the Chinese as a result of the pain and suffering their constituents are feeling; a transference of "please do something." That "something" will be to punish the Chinese without realizing, even if told of the consequences, that those consequences will be to punish themselves.

      Like Aykroyd in Ghostbusters when told to choose his destroyer, he said he thought of the most harmless creature he could imagine from his childhood, the Staypuft Marshmallow Man. Boom, in walks the 100ft version of your dream.

      Yes. They have before and they will again. They are a representation of the stupid herd.

      Not only possible, but likely.
      I agree. Not only is it a way for them to show the voters that they're doing something, but it makes China the bad guy instead of the US Government, Fed, Wall Street, etc. Shifting blame is always politically advantageous.

      Comment


      • #4
        Re: Will China Sell?

        How many times has Paulson been to China? He's obviously involved in some protracted negotiations. Looks to me like the Chinese aren't getting some things they want, and are creating a negotiating position with these threats. Doesn't necessarily seem like a big deal to me. I'm guessing that the Chinese are very well aware that Congress is going to take a few swings at them, they're trying to minimize the inevitable damage. And I don't expect it to be much damage, since reality is on the Chinese side. Nothing will stop the worldwide labor arbitrage no matter what Congress does, no matter how painful to e.g. residents of North Carolina formerly building furniture or making towels.

        Comment


        • #5
          Re: Will China Sell?

          What do you think Paulson has been doing in China? Of course he needs the Chinese to sell!

          What happens after the MBS,CDO implosion and re-pricing? Deflation. They [the U.S.] need China to monetize those bonds in order to rob them of their future purchasing power.

          The Chinese aren't stupid, they know their USD came from the monetization of real estate, they know it is in their interest to hold on to the Treasuries.

          In my opinion, I suspect that there is artificial market support in order to get the Chinese to play, but time is running out. I don't think Joe and Jane Sixpack can hold for another year.

          Beautiful chess game at hand people.

          -Sapiens

          Comment


          • #6
            Re: Will China Sell?

            Given that in modern Economic "wisdom" "Deficits don't matter" - does the U.S. Congress and Government even see the danger?
            I have been amazed that, while trying to project military power all over the place, successive Governments have allowed the nation to be white-anted from the inside with poor policy.
            I am aware that as an Australian I am living in a glass house!!

            Comment


            • #7
              Re: Will China Sell?

              Originally posted by EJ View Post


              Will Congress pull the trigger? Can they behave that irrationally and self-destructively?
              As usual, awesome graphic.

              Greenspan was a phenomenal politician. He garnered consensus among central bankers, Congress, and the White House. Bernanke, on the other hand, may not realize that it's his job to talk, convince, schmooze, and otherwise advise Congress in a less academic way.

              While EJ frames it as what will Congress do, I think the more pertinent question will be what will China respond with. Obviously, selling 1.2Trillion would be quite the nuke. But what about selling 200Billion. It's a 1/6 nuke that would make a significant scare. Jong Il Kim exploded a couple of nukes in a mountain and all the necessary parties came to negotiate, and quickly. China is different from Korea in that they already have the upper hand and I would imagine they would extract even more pain from us. We continue to export worth to them. To make a twist on an old phrase, it makes no sense for them to cut off our nose to spite our face. But, if it gets us to cooperate and work harder to give them more wealth, they just might.

              On the other hand, oil is denominated in US$, China will just posture.

              If oil becomes denominated in a basket currency or euro, I contend that China will use us to wipe their floors, build their railroads, and tailor their clothes a la 1800's. How? Maybe they'll buy less bonds, sell the ones they have, open the flood gates at the wrong time, whatever will keep them leveraged and still keep exporting wealth.

              As for the original question, Congress, thankfully, is neutered. As such, Bush will likely veto anything because Paulson tells him to.

              Comment


              • #8
                Re: Will China Sell?

                Originally posted by The Outback Oracle View Post
                Given that in modern Economic "wisdom" "Deficits don't matter" - does the U.S. Congress and Government even see the danger?
                I have been amazed that, while trying to project military power all over the place, successive Governments have allowed the nation to be white-anted from the inside with poor policy.
                I am aware that as an Australian I am living in a glass house!!
                White-anted... that's a new one to me. Aussie slang for termites, from what I gather.

                I'm of the opinion that most of our politicians are about as well-informed as Joe Sixpack when it comes to economic issues (or anything else, frankly). After all, they are lawyers, not economists. Most do not forsee the consequences of sanctions against China, and any that do are likely beholden to powerful interests who want them to ignore those consequences.

                It all comes down to who is bluffing in this game of chicken. The US may have the sportscar that could swerve away at the last second, but China has the freight train loaded with consumer goods.

                Comment


                • #9
                  Re: Will China Sell?

                  Originally posted by zoog View Post
                  I'm of the opinion that most of our politicians are about as well-informed as Joe Sixpack when it comes to economic issues (or anything else, frankly). After all, they are lawyers, not economists.
                  whatever do you mean, zoog? you aren't encouraged by the crack job our political leadership did steering us around the mortgage debacle?

                  Comment


                  • #10
                    Re: Will China Sell?

                    Originally posted by metalman View Post
                    whatever do you mean, zoog? you aren't encouraged by the crack job our political leadership did steering us around the mortgage debacle?
                    "It was the best of times, it was the worst of times" :rolleyes:

                    I have a dismal view of politics and politicians. With that perspective noted, I hope that somewhere in my lifetime we have some real leadership from the people pretending to run this country. Thus far I have yet to see any.

                    Originally posted by EJ View Post
                    If Congress does anything to significantly damage the domestic political position of the Chinese government, you can count on it. They have to. That is the unforgiving logic of the economic and political relationship between the U.S. and China. What is not known is just how strong or fragile that standing may be, and how even a seemingly minor political move by the U.S. might precipitate a political crisis in China.
                    This is an intriguing question. My speculation is that the Chinese government is in a strong position domestically so long as their economy continues to boom. Especially while their stock market continues to shoot for the moon, sucking in the sheeple along the way. I have read arguments on either side of the debate of whether a crash in their stock market would crash their economy. I say, it doesn't matter. When it crashes, and so many average Chinese have lost their life's savings, their homes, etc., the government will be facing a potential uprising. They will take whatever measures necessary to maintain stability and power, no matter what it does to the US or the rest of the world.

                    Comment


                    • #11
                      Re: Will China Sell?

                      In my opinition, China is dead serious about protecting the value of the accumulated cash reserves and will do everything to ensure their value is not shrinking with falling dollar and inflated asset prices.

                      Selling US bonds will raise borrowing costs to slow US dollar depreciation by borrowing. The US dollar will be supported by higher rates and lower financial asset prices.

                      The recent liquidity disruption in US credit market could be a warning message to US caused by massive yuan-denominated bond offering at the end of June. The US should take China seriously. China government seem to follow through on their promises.
                      Last edited by idianov; 08-08-07, 02:13 AM.

                      Comment


                      • #12
                        Re: Will China Sell?

                        My view on China is much more prosaic.

                        I actually believe that the government in China is much more likely to act a la Putin than to change into a 'democratic' or euro-socialist government.

                        Putin has demonstrated that it is possible to (at least short term) use governmental power to secure geostrategic resources for government geostrategic empowerment without upsetting the military portion of balance of power. There are other examples such as with Venezuela.

                        I suspect the only reason China has not done so is that they do not yet recognize that their production cost advantages can amount to the same thing - or at least that any public acknowledgement of this would eventually lead to the population realizing that they are collectively, permanently, going to be poor relative to those who consume Chinese output.

                        I base this belief on official China white papers even from 5 or more years ago which have talked about how it will be impossible to achieve Western lifestyles, but which explicitly fail to explore the corollary that then that strictly speaking, the allure of capitalism as a whole is complete fiction for the overall populace.

                        Of course, this is likely because no one has any clue as to how far China can improve their economic situation given that they are much larger than any other nation.

                        It could very well be that China is only using capitalist/mercantilist policies as far/long as they are able to, after which there will be some other plan.

                        The money accumulated in this process is only a tool, and tools can be discarded or broken in order to achieve higher goals.

                        Comment


                        • #13
                          Re: Will China Sell?

                          Losing our manufacturing capability is a national security issue. Once it's lost it's difficult to get back because the expertise has disappeared and is not passed on to the next generation. The time to have done this was when China's USD reserves were only $200 B.

                          How does Germany keep her manufacturing capability even at 1.38 Euro and we can't keep ours with a dollar breaking down thru .80 USDX?

                          Comment


                          • #14
                            Re: Will China Sell?

                            The Chinese do not have to sell treasuries. They can use their trillion dollars of forex reserves to buy yen. This would result in the yen strengthening and an end to the carry trade with huge damage to US investment banks (Paulsen's Goldman Sachs), hedge funds, etc. This would fit in nicely with the demand from Iran that they want to be paid in yen for oil--another reason for the Japanese to "let" the yen strengthen against the dollar.

                            Comment


                            • #15
                              Re: Will China Sell?

                              Originally posted by c1ue View Post
                              My view on China is much more prosaic.

                              I actually believe that the government in China is much more likely to act a la Putin than to change into a 'democratic' or euro-socialist government.
                              I'd actually argue that Putin is the one who learned from China...they were the ones who have been able to enable economic growth while so effectively preventing civil liberties and personal freedom from getting in the way.

                              Either way, it is clear that the interdependence is a good thing and a bad thing. They need us as much as we need them. Better that way rather than an imbalance which could result in military agression rather than just trade policy bickering...

                              I expect there will be Congressional rumbling but lack of real destructive action. Election years are great for whipping out the flag, blaming economic hardship on those poor quality Chinese manufacturers, who we can't trust, who clearly stole American jobs, and who are irrationally holding a financial club over our heads. Well, we won't stand for it Mr. and Mrs. America...Vote for me and we will protect you and bring jobs back to the US. But then more of the same, and it will all just be posturing.

                              I do think the threat of a 200bn bond sale is a real one though. Despite my b-school finance classes, I still don't feel comfortable trying to make bets in the bond or options markets...all that price/yield and put/call stuff makes my head spin.

                              Comment

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