02/23/10 Melbourne, Australia – Recently we claimed that borrowing your way to national prosperity is a sure-fire way to servitude and political instability. Today, we aim to prove it. To do so, we cite this article from Reuters. It suggests that China is using or should use its large holdings of US Treasury bonds as a cudgel with which to bludgeon the United States, its strategic adversary/indispensable economic partner.
Figures in the People’s Liberation Army want the financiers to sell US bonds as a way of punishing Washington for selling arms to Taiwan. Mind you this might not seem like such a good idea if the bond selling triggers a run on the dollar and swift devaluation in China’s forex reserves. But maybe China’s arsenal of US bonds is like a pile of bullets – they’re no good unless you fire them.
Of course what we’re suggesting is that China accumulated US debt as both a by-product and a weapon. The huge stock of US government securities was a by-product of China’s trade strategy. That strategy was to keep its currency low and gain global manufacturing market share through low labour and production costs. The result was a blizzard of US dollar trade surpluses that were reinvested into US bonds.
You could say it’s China that’s paid for the wars in Afghanistan and Iraq.
But why is this bundle of bonds now a weapon? We think China’s export-driven growth strategy is on its last legs. Labor unions in Europe and America – given today’s political climate and high unemployment – will have the ear of politicians. And they will be saying something like this, “Make the Chinese pay!”
What they’ll mean is that China will be pressured to give up its main economic weapon – currency manipulation. This has kept Chinese exports cheap all over the world and led to the gutting of American manufacturing jobs. It’s made it pretty tough on exporters in Europe too. As a result of China’s dollar peg, European exporters suffered doubly from a weaker US dollar. American goods were cheaper in Europe. But European goods were not cheaper in China.
So the unions and the politicians will probably not tolerate another leg of the global recession in which China gains more market share by keeping the currency peg and exporting its way to more growth (if growth is to be had). It brings us to the end-game of China’s export-driven development.
It also brings us back to one of the great monetary questions of the day: when will China de-peg? The answer has always been simple: when it is in China’s interests to do. To us, that means China will de-peg when the benefits of increased purchasing power in the currency are more important that dwindling export profits.
In other words, we think China is close to a new phase of growth that’s driven by consumer demand, domestic consumption, and more mature Chinese capital markets open to foreign investment. A de-pegging of the currency would see a much stronger yuan. This would give Chinese savers a lot of spending power on global markets. They would also be able to buy more Chinese goods, which might lead to higher wages in China too (and more stoking of consumer demand).
This is all a theory, of course. And we could be way wrong. But there will come a day when Chinese customers are worth more to Chinese producers than American customers. De-pegging the currency will bring that day forward. And it could be sooner than you think.
This means that the accumulation of forex reserves was never really meant to protect China from external trade shocks, although they would be handy in that event. It means they were a side effect of a trade strategy whose ultimate objective was to gain as much global manufacturing market share as possible.
Now, you might wonder why China would damage its own interests by “punishing” the United States and selling bonds. But it depends on what China’s interests are. If China’s interests are in fundamentally weakening an economic competitor and strategic adversary, then selling US bonds is in China’s interests.
China’s ultimate interests are in regaining Taiwan. And we’d suggest it try and use its bond leverage to weaken US resolve about defending Taiwan. And selling US bonds or crashing the dollar wouldn’t just weaken US resolve. It would expose the loss of strategic influence that occurs when you are a chronic debtor nation.
Mind you the US still has a lot of aircraft carriers, strategic bombers, and nuclear weapons. It’s not like it is bereft of tools of persuasion. But the basis of all those tools has always been a strong economy, a strong industrial base, and sound finances.
The question now is, if the base of military strength has been eroded, how long will the US maintain its military advantage? Can America afford it? And when push comes to shove, will American voters demand that an American President defend Taiwan? Hmmn…
Dan Denning
Dan Denning is the author of 2005's best-selling The Bull Hunter. A specialist in small-cap stocks, Dan draws on his network of global contacts from his base in Melbourne, Australia, and is a frequent contributor to The Daily Reckoning Australia .
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1. China didn’t devalue its currency. They just pegged to the USA, which devalued theirs.
2. Both US and PRC workers got shortchanged. The Chinese workers made real goods and received in return some ever-depreciating dollars. The US manufacturing workers lost their jobs but got some cheap stuff.
3. The advantage to China is that at least from a national point of view, they gained a lot of know-how a lot faster than they could have expected otherwise. Since Chinese are for the most part good patriots, perhaps that’s a comfort for the people who left their farms to crowd into shanty suburbs.
4. The advantage for the USA was that top ten percent made a lot of money from investments. Since Americans are for the most part good patriots, no doubt lots of people take pride in all those fancy cars and gated communities.
5. The USA can relax on the military question. The developmental lead times for state of the art weaponry are very long–on the order of 20-25 years. Besides, China’s newly industrial economy is heavily dependent on raw material imports, which can easily be cut by the US global network of garrisons, in the event of a conflict.
6. The Chinese have made investments in many resource regions, but without the blue-water fleet and interhemispheric stealth aircraft, their contracts are nothing but pieces of paper. Sovereigns enforce contracts. Arms make sovereigns. China can make global contracts, but the USA is the global sovereign–the worldwide enforcer of last resort.
7. The Romans didn’t rule the Mediterranean because they had the most productive economy. No. The Romans had the most terrifying war machine, so everyone else had to labour, while the Romans went to the baths and the chariot races. Unsustainable? Of course it was unsustainable–it could only last four or five centuries…
I say this again and keep saying it. China is not our friend. They have long range plans for us and it does not include or bode well for America. Those that invest in China are cutting our throats for short term profits. They also are not our friends. Pitiful.
All this stupid nationalism is sickening and will lead to disaster.
“I say this again and keep saying it. China is not our friend.”
stupid nationalist remark ^^
China will de-peg when there’s something they want and cannot afford.
A global crop failure and a need to purchase US grain might cause this.