- Registration time
- Last login
- Online time
- 47 Hour
- Reading permission
Reply #7 wanzheli's post
>who is gonna buy American bonds|
The Federal Reserve will buy them. This has already been announced. However the practice of buying your own bonds when they are issued is (as we have discussed in other threads) esstentially equivalent to printing money. The debasing of the currency will over time have a tendency to increase US domestic inflation and reduce the value of the dollar. From the overall standpoint of US society, this is advantageous initially as overall US society is a debtor, and this will allow the repayment of existing debt in less valuable paper. Over time however as lenders (both US domestic and foreign) begin to understand that this is a systemic policy, they will be less willing to lend in dollars. This has significant implications, but is probably several years out in the future.
>China will not stop buying American bonds, slowing is already the worst senario.
There has been a lot of ink split about this in the mainstream press as well as on this BBS. Needless to say, some clarification is needed here. China, both through its national institutions and through private ones, owns a lot of US$ denominated debt. This debt spins off interest which annually itself is a formidable amount of money. An even larger amount is received in the form of principal repayments (a certain amount is of the debt held is maturing every year). All that money is received in dollars and Chinese investors need to make an active decision about what to do with it. There is a second source of funds which in the last few years has been an even bigger source from which China has purchased US$ investments. And that is funds from China's trade surplus.
Going forward, China's trade surplus will essentially be eliminated. We've seen that already in the 1st quarter of this year when China's trade suprlus fell by some 90% vs. a year ago. This is the direct reason why China's purchases of US$ denominated assets have slowed so dramatically so far this year. And this is likely to continue for the rest of the year. Remember that large merchandise trade surpluses are NOT a historic norm for the PRC. It has only been in the last few years that China has run a large trade surplus. As China moves back to more normal circumstances, the trade surplus is likely to be small or even non-existent, which means that by default the massive inflows of funds into the dollar are over. Thus wanzheli's "worst scenario" is in fact probably the base line scenario.
But what then of the funds that Chinese investors own that are already in the US$, as I mentioned above? To date there has been little observed outright selling by Chinese investors. And the market expects that there will be little of this. Were it to occur, massive US gov't intervention, perhaps even introduction of fixed, government mandated interest rates might be necessary to stabilize the US capital markets. As such a catastrophe is not desirable from China's viepoint, there is little motivation to engage in large scale selling. The threat then is more gradual and comes from China's own domestic capital needs. The PRC's central government is for the first time in about a decade, running a meaningful budget deficit. The need to fund that deficit means it needs to sell bonds. Bonds which to Chinese investors offer about twice the interest rate that US gov't debt offers (~4.5% vs. 2%) AND no currency risk. Such debt will prove to be incredibly attractive to Chinese banks. If the PRC's debt financing needs are short-lived, then little will come of this. But if the PRC needs to enact repeated fiscal stimulus (stimulii) and has a long term need to fund deficits, then this will eventually trigger selling of US$ assets by Chinese investors so they can buy ever increasing amounts of Chinese gov't debt.
Thus it can be seen that while for now US gov't funding is still relatively sheltered from international competition, the day is not far away when the US will need to compete for capital against all other borrowers, both soverign and private. This is something that Latin American governments have had to deal with for some time. And not always successfully. How the US adapts to this competition will be a key factor in determining how it does for the remainder of the first half of this century.