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  • PLA Threatens Chinese Economy

    Chart

    China’s People’s Liberation Army (PLA) this month has been trying to threaten the U.S. economically. However, their plan could actually harm China, not America.

    Many, many Chinese see reunification with Taiwan as a deep emotional issue. But much of the PLA sees it as a way to pad the military budget. Any attention to Taiwan has Chinese generals demanding some sort of strong action or another, while naturally observing that the controversy justifies more money for them.

    This happened again with the recent announcement by the Obama Administration that it will provide limited arms to Taiwan. The PLA trotted out its most bellicose officers. These worthies promptly argued, among other things, that China should respond to the arms sale with a bond sale, selling down holdings of American bonds.

    Bring it on, guys.

    The idea that China has important influence over the United States through its bond holdings is a myth. If a picture is worth a thousand words, the graphic to the right should be particularly valuable.

    There are only two real economic possibilities:

    1) China sells bonds, for a purely political reason, and finds strong demand from everyone else, here and around the world.

    China then holds less U.S. government bonds and others (American banks, the Japanese government, ordinary people, and so on) hold more.

    2) China tries to sell American government bonds, for a purely political reason, but no one else wants them. Even in this case there still is no threat to the U.S.

    That’s because China’s attempted sale has nothing to do with the U.S. economy. People and countries do not buy American bonds because China does, they buy because it’s the best financial option for some particular amount of money. How good an option it is changes with economic conditions, such as our horrible budget deficit. But how valuable U.S. government bonds are does not change because the PRC is throwing a tantrum about Taiwan arms. Other buyers of our bonds will ignore this, and there’s even a fun twist.

    If the Chinese government actually listened to PLA bluster and made a grand announcement about selling bonds, they might feel they have to follow through or lose credibility. But in the case of no one wanting them, that will not work at first.  To find buyers, China would then have to cut the price and take losses on the bonds.

    If that opportunity were to arise, The Heritage Foundation suggests that the Department of the Treasury buy the bonds at the lower price saving taxpayers a bit of the money the U.S. government is wasting. At the end of the day, China could have done the U.S. a favor.

    Thanks for the help, PLA.

    Posted in Ongoing Priorities [slideshow_deploy]

    7 Responses to PLA Threatens Chinese Economy

    1. RC, Boston says:

      "If that opportunity were to arise, The Heritage Foundation suggests that the Department of the Treasury buy the bonds"

      Yah, smart idea. The Treasure Department can buy back all the budget deficit – that is moer than 3 trillion dollars. The US government asks China to continue buying its bonds and Treasure bills. Do you understand what 'US owe China' means? If one has money, one won't be a debtor, not to mention the biggest debtor. Treasure department can print more greenbacks, however, the more it prints, the less these will be money.

    2. michael says:

      this guy sound like an idoit. do u know what u r talking a bout? if china sell the bond, meaning the interest will goes up. if interest go up,then there is a higher cost do business in this country. think harder!. do u think it has no negative effect in this country.

    3. Zhu, Bajie, Hong Kon says:

      Wow, these guys are so smart, they really make these convoluted concept easy to understand. With a graph, Duh!! Why didn't I think of that? See, to make that China number look smaller, all you have to do is increase the American deficit, and if China won't buy that debt, there'd be many others who would!!! What brilliant observations – you've gotta hand it to these HF guys.

    4. Derek Scissors, Ph.D. Derek Scissors, Wash says:

      Zhu Bajie: I don't understand the point of your sarcasm. There used to be a widespread belief that the US couldn't expand its deficit without China buying a great deal of bonds. What actually happened is that the US deficit quadrupled in 2009 — which is absolutely terrible — and China bought half as many bonds in 2009 in 2008. Yet American interest rates fell. That is what the graph shows.

      The idea that the US needs China to buy Treasury bonds has been established as false and those who argued that established as being wrong. If we want to continue our self-destructive policies, we don't need China for that.

      Derek

    5. Feng, New York says:

      Wow, this is pretty amazing. Hank Paulson said that in the Beijing Olympics, Putin approached China about selling all of its agency debts to hurt America. Of course, China ended up not doing that, but US gov't was forced to back the agency bonds in order to prevent China from the massive sell-off of fannie and freddie bonds. Hank said this knowing the effect that it could have on US economy. Back in 2008, US gov't sold enough Euro/gold for a 2 to 4 cent jump on the dollar before it put in the $700 million bailout. As a result of that, all of the short position leveraged against USD started to unwind and we saw a huge comeback for USD all the way to early 2009. And consider how little foreign exchange US has. Now, if China decides to sell the entire $2 trillion+ it holds in agencies and treasury. All of the rest of the major hedge funds, banks will also put up huge short positions against USD. Because now, not only are 6% of the entire US treasury getting sold, you know one of the major buyers is getting out of the picture. You will get to a position where the treasury will have a much higher interest rate on the medium to long end or fed will have to buy a lot of bonds to keep the yield curve from going out of the control. Or more likely, the yield curve will climb and Fed will have to print a lot of money at the same time. From that, you will get a massively depreciated currency.

      Now, I personally think that China has to sell all US holdings regardless of political ramifications, because it's just a really bad investment. Consider the amount of debt that US gov't has in treasury and agency holdings + private sector debt + state debt, you will have the mother of all bubbles soon. Japan has already stopped buying US treasuries. If China doesn't do it, it will easily loose 25% of its holdings or more on depreciated purchasing power. At the same time, US will experience a lot of pain, but it's in the best interest of the country for China to sell the debts in the long run. It will be forced to run a more fiscally well managed gov't and also have less debt in purchasing power, because the depreciated currency will reduce the real debt. Yes, country will end up poorer, but that's what happens when you accumulate this much debt.

    6. bob says:

      Wow, the US don't need China to continue to self destruct, the US can self destruct all on its own, and the winner is, the US?

      Just look at Greece, they certainly didn't need Chinese help in getting to the brink of bankruptcy, for that they have their European and British friends. Look just how awesome they are doing these days.

    7. John Wellington says:

      China is more than willing to finance US purchase and defense spending during wartime and peacetime measures.

      If this trend continues, America would think she has an unlimited credit card line, and by the end, she will have gotten herself in a lot of debt, she will no longer be in a fiscal position to become a world policeman anymore.

      Just keep on spending USA.

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