"The failure of the "you-buy-our-goods we-buy-your debt" may well be coming to a close"

On Angry Bear, a post from stormy:

"Symbiotic Relationship between U.S. and China about to Fail

Global imbalances are about to take a dangerous turn, one that will make any escape from the present crisis almost impossible. We are on the brink of watching ill-designed global financial and trade policies collapse globally. ( THIS WILL BE BAD NEWS )

These policies have many players( TRUE ), not just the U.S. (The U.S. just happens to be one of the important lynch pins.) All have contributed their share, driven by self-interest and foolishness. No wise man has been at the helm( THERE IS NO SUCH THING AS THE HELM ). The mechanisms for this global collapse have been long in the making. Many of them have been studiously ignored or pooh-poohed; others have been celebrated as the new, marvelous world order.

The simplified version of this mechanism is: China has been not only one of the major purchasers of U.S. debt but also one of the main beneficiaries of the U.S. trade deficit.( TRUE. THE SAVER COUNTRY/SPENDER COUNTRY SYMBIOSIS )

That mechanism may be about to fail( DON'T COUNT IT OUT YET ). If and when it does, the entire global edifice will shudder. ( TRUE. IF IT DOES. )

(rdan here...Menzie Chin weighs in with some good charts at Econbrowser)



Looking at the present fiasco from a global perspective may help the world later when it seriously tries to rebuild. If this post has any silver lining, that is it.

For a long time, China parked its export earnings in U.S. bonds--T-bills, agencies, etc--, keeping U.S. interest rates low, all of which contributed to the U.S. credit boom. (Greenspan is not the only villain; nor are the greedy banks with their subprime come-hither looks and their credit card gotchas.)

Many argued--including some commentators in this blog--that the U.S. did not have to worry about China--or any other country--losing its appetite for U.S. bonds. Such a country would be foolish to do so; after all, the U.S. is the strongest economy in the world and the dollar is the safest currency.

When Fannie and Freddie failed, Treasury insured that China's investment was protected even at significant cost to U.S. taxpayers. The implications were clear: Always treat your major creditor with respect.

Purchase of U.S. dollars was one way in which China kept its currency artificially low, providing steam to its export machine. Earlier this year, faced with a declining global appetite for its exports, the Peoples' Bank of China forced its

commercial banks to build U.S dollar reserves, in a move that holds down the value of the Chinese Yuan, and in effect implements exchange rate intervention, have been revealed by HSBC’s currency team in Asia. The central bank has moved five times in five months to increase the reserve requirements, and stepping up the rate of increase with two extra moves in late June. The moves have increased the mandatory holdings of dollar reserves, from 15% to 17.5%, of anything that is lent out by commercial banks. The impact has been to peg the Yuan lower, and in that in effect has eased the burden of Chinese exporters struggling with a global economic slow-down.

(Many of those Chinese exporters are, of course, foreign firms inside China. According to Vice Premier Wu Li, in 2006 as much as 85% of Chinese exports were FDI driven.)
This dangerous symbiotic and unbalanced relationship between the U.S. and China may fail in 2009-2010.( MAYBE )

Right now, the demand for T-bills is enormous( THE FLIGHT TO SAFETY ), driving the interest of T-bills almost to zero. Watching their life savings disappear into the present financial cesspool, many have simply tried to protect the remaining principal by purchasing T-bills. They want to protect what is left before it too disappears( THE CALLING RUN AT THE LEVEL OF THE INDIVIDUAL ), a slight improvement on the old-fashion mattress approach. (Some opt for gold. Better put that in the mattress, too.)

As the recession deepens dangerously, China may well be thinking twice before it continues old habits. A recent New York Times article outlines why old may be changing.

In the last five years, China has spent as much as one-seventh of its entire economic output buying foreign debt, mostly American. In September, it surpassed Japan as the largest overseas holder of Treasuries

Instead of buying American debt, China is now diverting its huge reserves to its own stimulus package.( THIS IS GOOD )

But now Beijing is seeking to pay for its own $600 billion stimulus — just as tax revenue is falling sharply as the Chinese economy slows. Regulators have ordered banks to lend more money to small and medium-size enterprises, many of which are struggling with lower exports, and to lend to local governments to build new roads and other projects( YES )

Furthermore, as its export machine falters bringing in fewer reserves, China will have less to invest in U.S. bonds.( TRUE )

There is, of course, a dangerous feedback mechanism here: China will be in a weaker position to protect its peg against the dollar, which in turn will weaken its already weakening export machine.( THAT DEPENDS UPON THE DOLLAR'S VALUE AS WELL )

And what about multinationals in China? Well, FDI in China is shrinking.

Multinationals are hoarding their cash and cutting back on construction of new factories.( THE PROACTIVITY RUN )

China may have to depend on its own, rather weak, consumer base. All of this may seem like good news to some. After all, maybe those multinationals will come home. I doubt it, certainly not for a good while. Furthermore, like the banks and you and me, they are trying to protect their own principal. Everyone is seeking safety. All these stimulus packages may be coming too late and be far too little. Conversely, if the correct policies had been in place, no such stimulus package would ever have been needed.( TRUE )

The current situation certainly has all the earmarks of a serious Depression. Increasing aggregate demand is becoming a global problem.( TRUE )

Furthermore, the U.S.-China trade imbalance is now coming back to haunt China. As I pointed out, its consumer base is far too weak( I WOULD SAY UNABLE TO BECOME SPENDERS, ALTHOUGH MANY OF THE VERY YOUNG ARE SPENDERS ) to support the appetite for the kinds of exports it sent to the U.S. and elsewhere.

And what will the U.S. do if its favorite creditor is forced to look inward? Just how will it finance its mammoth, ever-growing U.S. debt? It won't. Its only recourse will be to print money( A GOOD IDEA ), more money, and more money( HOLD ON MATE ). We know where that path leads.( NOT NECESSARILY TO HYPERINFLATION. )

When China and Japan keep their money at home to rescue and to stimulate their own economies instead of financing our debt, expect our interest rates to rise--and there will be few buyers.( EXPECT THEM TO ALLOW US SOME DEFAULT )

The failure of the "you-buy-our-goods we-buy-your debt" may well be coming to a close.( IF SO, THE LOOK OF OUR GOVERNMENTS AND SOCIETIES GOOD LOOK VERY DIFFERENT IN THE FUTURE, AND, HERE'S WHERE I'M A BURKEAN, THESE CHANGES WILL BE TOWARDS NATIONALISM AND TOTALITARIANISM. )

Posted by Stormy at 3:13 PM "

"If you ask me, it is because of fear"

Here's a post which explains why I believe getting Saver Nations to spend could be hard. Hung Huang on Economix:

"We Chinese are the biggest savers in the world.

We had a personal savings rate of 25 percent and a national savings rate (which includes corporate savings) of 47 percent in 2005, compared with a personal rate of 0.5 percent and a national rate of 12 percent in the United States that year. (Last month, the United States personal savings rate was 2.4 percent.)( THAT'S A SAVER NATION )

This year, to make sure the economy will continue to grow at 8 percent, the government is trying to stimulate domestic consumption. So far, it is not working; no one is out there on a shopping spree. Most Chinese, even if their monthly income is less than $100, still manage to save quite a bit of money. ( I'M NOT SURPRISED )

Why?

If you ask me, it is because of fear ( I FIND THIS TO BE A HUMAN AGENCY EXPLANATION, AND PLAUSIBLE ) — fear that our parents will get old and no one will take care of them; fear that if we get sick, no one will take care of us; fear that when our children go to school, we will not be able to afford the best education. Unfortunately for us, we have a very dilapidated social welfare system. Things that are supposed to be free actually are loaded with hidden costs.

My mother passed away in the beginning of the year. She had worked for the government for 40 years, and the government was supposed to cover her health care expenses. However, we found out that when it came to prescribing treatment for her, all the imported medicines were not covered by the government health plan. One antibiotic injection that she needed costs $1,500 a day. There was no chance that the state-run hospital would take an I.O.U.; we had to provide the cash beforehand.

What was worse was that the doctors needed to be paid on the side. A friend of mine paid $10,000 to a surgeon so that he would operate on her ailing father. Things like that are very common in China. I have another friend who works for a Western pharmaceutical company. Her job is to take all the doctors on fancy vacations so they keep prescribing her company’s medicine for their patients.

China is also supposed to have a free education system. Never mind the quality of the education. Let’s just tally up the cost. If I want to send my daughter, who is 3, to one of the top preschools in Beijing, it will cost me about $1,000 a month. I live on a small street with a famous primary school. As a rule, I have the right to send my child to the school since I live in the neighborhood. If I did not live here, I would need to pay a $10,000 to $30,000 sponsorship fee to the school. But I was told the “free zone” of the school for the neighborhood has been getting smaller and smaller. Probably by the time my daughter is old enough for primary school, we will not qualify anymore, although our house is only about 100 meters from the school.

As for myself and my husband, we have to save for our old age. We are not sure whether the government will have any social welfare for the elderly by the time we retire in 15 years. However, whatever that social welfare might be, it will not be enough to live on.

Take my mother for example. She was a government official, and the widow of a foreign minister. She received at the time of her death, about $230 a month. She certainly could not live on that amount, so it was good that she wrote some best-selling books, and the royalties could help cover her expenses.

Aside from all the above reasons, the Chinese also save for their children and their grandchildren. When my mom passed away, I found that she has saved a great deal of money — about $300,000. She has put it into an education fund for my daughter. “When Ping Ping gets into Harvard,” she said in her will, “I want you to use this money to pay for her tuition. It is my last gift to her.”

Good luck on the Stimulus. I think that the Government will have to spend the money.