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Monday September 21, 2009 - 20:38:08 GMT
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Does China Have a Lease on America's Future?
When yields on the 10
Year Treasury note were climbing to 4.0% last spring bond traders fears were
focused three items: the Federal Reserveâ€™s liquidity provisions, the Obama
administrationâ€™s ten year deficit projections and the inflationary potential of
both programs. The collapse in Treasury prices prompted the Fedâ€™s entry into the
Treasury market. Its $300 billons program to purchase government debt led to
suspicions that the US Government had embarked on direct monetization of its
debt, printing dollars to make up for the revenues it no longer had. As the
Treasury began to auction its debentures these fears undermined confidence that
investors would accept the new issuance at market rates.
US Generic Government 10 Year Yield
China and Russian were the most
vocal about the danger to their American investments from a collapsing dollar
but the risk applied to all holders of US notes. The Chinese and the Russians
outlined their concerns in clear and unusually plain language. Chinese officials
warned the US government to be mindful of its status as the world's largest
holder of US debt and cautioned Washington to act as a careful custodian of its
currency. The Russian were blunter, calling for a new world reserve currency to
replace the dollar.
If the debt markets did not readily buy American
notes because of worries about the US dollar, American bond rates would be
forced higher dragging mortgage and other US rates with them. The US
governmentâ€™s efforts to limit the economic damage of the financial crisis and
recession would be far less effective with higher mortgage and credit card
rates. Few economists and officials then thought the American economy could
tolerate a substantial rise in rates.
But rhetoric aside, the Chinese
had reasons of their own to fear what would have been a dangerous fall in the
Treasury markets and the consequent rise in American interest rates.
China depends on the worldâ€™s economy to buy her exports. If the US
Treasury markets had cratered in the spring the effect on the US economy and the
world could have been catastrophic. In the frightened atmosphere that risk was
At the very least a collapse in the Treasury market would
have heightened the sense of disaster that was just beginning to ebb, seriously
deepened the recession and hastened the decline in world trade. In that febrile
atmosphere a Chinese withdrawal from the US Treasury markets would have had
Chinese exports contracted dramatically in the late
fall, winter and early spring. Factories closed, millions of migrant workers to
the cities were thrown out of work bringing with them the specter of civil
unrest which is never far from the minds of the rulers in Beijing.
the US began its Treasury auctions Chinaâ€™s immediate self interest kept her
actively involved. As the most visible of the worldâ€™s governments participating
in the Treasury market any sign of actual withdrawal, as opposed to theoretical
criticism, would have had a dire effect on the worldwide appetite for US debt.
China clearly had and has a present interest in keeping the US Treasury
market from sinking and in keeping US rates low and the US economy on track for
the strongest recovery possible. But there is also a long term Chinese interest
in fostering the US debt binge.
The Obama administration has embarked on
the largest expansion of US debt in history. Its legislative plans include the
greatest addition to government services since the Depression. Such a program
cannot be accomplished without the cooperation of the worldâ€™s credit markets;
the leading buyers of US debt are other governments with China paramount. If
China does not acquiesce to the increase in US debt the administration will have
a much harder time enacting its plans. The most likely political result in
Washington would be a curtailment of US Government spending and a drop in the
amount of debt that the Treasury would have to issue.
But if the
administration is able to complete its economic agenda the result will be an
enormous increase of US debt and eventually higher taxes to pay for those
programs and the debt.
The exaction that this debt will take from the US
economy in lower productivity and economic growth will permanently alter the
position of the US economy in the world. If the administration completes its
agenda then the dollar will decline, slowly but inexorably, as the US economy
slips from its position as the most vibrant mature industrial economy and loses
it position as the world's largest national economy.
The possibility for
a devaluation of Chinese dollar holding is very real but perhaps Beijing
considers it a down payment on the future. Would it not be a worthy price to pay
for assisting the self-imposed crippling of her greatest economic competitor?
Chief Market Analyst
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