Dean Baker
By Dean Baker
Co-Director, Center for Economic and Policy Research
Most of the economists and pundits who could not see an $8 trillion housing bubble are telling us that the United States desperately needs for the Chinese government to keep buying its debt. This crew of failed analysts argues that without the support of the Chinese government, interest rates in the United States will rise, choking off the recovery. In reality, the decision by China to stop buying U.S. government debt may not harm the economy’s recovery, but it could be devastating to the recovery efforts at Citigroup and other basket case banks.
The basic logic is simple. China’s central bank has been buying up huge amounts of dollar-based assets for the last decade. Their purchases include short and long-term government debt, mortgage backed securities and to a lesser extent private assets.
The Chinese central bank’s purchases have two effects. First, they help to keep interest rates low. This supports economic growth by keeping down the interest rate on mortgages, car loans and other borrowing that boosts demand.
The other effect of China’s purchase of dollar-based assets is that it keeps down the value of its currency against the dollar. This is the famed currency “manipulation,” that draws frequent complaints from politicians. Of course, it is not exactly manipulation. China has an explicit policy of keeping down the value of its currency against the dollar. It is not buying up hundreds of billions of dollars of U.S. assets in the dark of night. It does it in broad daylight in order to keep its currency at the targeted rate.
Suppose China stopped buying up U.S. government debt. Interest rates in the U.S. would rise, which would have some negative impact on growth. Of course, the Fed could try to offset this rise in rates by simply buying more debt itself. It has already been buying debt and it could simply buy enough to replace the lost demand from China. This would leave interest rates largely unchanged.
Suppose that the Fed doesn’t intervene and lets interest rates rise. This will have some negative impact on growth, but there will also be a very positive side from China’s decision to stop buying dollars. The dollar would fall in value against China’s currency. This would make Chinese goods more expensive in the United States, leading U.S. consumers to purchases fewer imports from China and more domestically produced goods.
A lower-valued dollar would also make our exports cheaper in China. That would allow us to export more to China.
The net effect would be an improvement in our trade balance, bringing back some of the 5.5 million jobs that we’ve lost in manufacturing over the last decade. In fact, since nearly all economists agree that the current trade deficit can’t persist for long, China would be helping the country bring about a necessary adjustment if it stopped buying up dollars.
Even the rise in interest rates would have a positive effect since it would allow for the completion of the deflation of the housing bubble, with house prices finally settling back to their trend levels. This drop in house prices will be a painful adjustment, but there is no way to avoid it. Bubbles cannot be sustained indefinitely and we are better off allowing the housing market to return to normal so we can get back to a path of sustainable growth.
While decision of the Chinese to stop buying dollars might be good for the economy, it is likely to be disastrous for Citigroup and the rest of the basket case banks. If interest rates rose, then the value of the government bonds they hold would plummet. If the interest rate on 10-year Treasury bonds goes from the current 3.5 percent to a still low 4.5 percent, then the banks will have lost 8 percent on their holdings. At a 5.5 percent interest rate, a rate that would still be far below the average for the 90s, the loss would be 15 percent. Citi and the other basket cases could not endure these losses in their current financial state.
This could be why we see shrill pronouncements from the likes of the Washington Post editors, and other “experts” who couldn’t see an $8 trillion housing bubble, that we need the Chinese government to keep buying up our debt. We absolutely do not need the Chinese government to keep buying U.S. debt and would almost certainly be better off if it stopped tomorrow. Citigroup and the other big banks do need the Chinese government to keep the money flowing if they are to have a chance of getting back on their feet. And, we know where the sympathies of the Washington Post’s editors and other “experts” lie.
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Dean Baker is the author of the new book, “Plunder and Blunder: The Rise and Fall of the Bubble Economy.”
This piece was first published on Huffington Post.
October 20th, 2009 at 9:01 pm
US citizens do not want to work for a small fraction (less than 5%) of the wages that would be necessary for re-industrialization of the USA.
The government raises money by selling freshly printed-paper T-Bills, US Government Bonds, and other US currency instruments in return for privately earned and held foreign US Dollars that foreigners earned by manufacturing things for international trade, mainly consumer goods for the USA importers, at US Federal Reserve Bank (the FED) public auctions. The buyers are private individuals, banks, and government agencies in China, India, Brazil, Pakistan, and other industrialized countries who earned US dollars from US importing companies.
These paper bonds and documents are redeemed for title to US located proprtyies and other assets that were generated by previous generations in lieu of US government redeeming these paper documents for gold.
These privately owned US located assets are finite, and the day will come when there will be nothing left to sell to foreigners in exchange for our freshly printed-paper T-Bills, US Government Bonds, and then we will then have to re-industrialize because US citizens will then no longer be able to pay foreigners to work and make the things that US citizens now consume.
October 20th, 2009 at 9:09 pm
Real wealth and real monetary value is created only when the members of a family (or a tribe, nation, city-state, etc.) plant, grow and/or harvest something of commercial value from the earth, extract something of commercial value from the earth, provide professional services (medical, legal, dental, engineering, architecture, accounting, land surveying, technology, etc.), and/or manufactures or constructs something of commercial value that is consumable (or permanently useful for income or rent) and then sells, leases or rents these items and/or services to parties outside of their family in return for a net transfer of gold, currency or commodities from other parties outside of their family into their own family. The members of that family can reflect their real wealth with the accumulation of grain, gold, cattle, jewels, land, buildings, commodities and/or other marketable products for reserve use in times of emergency and/or also to raise the standard of living for the members of that family.
The USA is selling our children’s legacy, including title to all of the wealth accumulated by previous generations in order to pay people in foreign countries to work and produce the things that US citizens consume, so that this will keep the USA from re-industrializing and having US citizens working to produce the things that US citizens consume and to pay for federal government spending. This is “sort-of like” US citizens selling our body parts to keep from working! The US government calls this “Investing in America”. US citizens are racing to sell title to everything in the USA of value that was created by previous generations in order to keep from working.
The USA will very soon run out of title to any privately held assets that foreign manufacturers will want to purchase or redeem with their freshly printed US government currencies and securities that they purchased at Federal Reserve auctions with the US Dollars that they earned by making items for US consumers.
October 20th, 2009 at 9:15 pm
Free trade has destroyed the ideal middle class dreams and opportunities that were expected after the 1960’s for those who worked hard.
Only US import tariffs high enough to prohibit imported products from being imported and sold in the USA will create re-industrialization, stop the flow of title to privately owned US assets from the USA, re-create the value of the US dollar, and also create manufacturing jobs for US citizens.
If US citizens are not willing to work for lower wages than the foreigner workers employed in foreign countries are paid, then the USA cannot compete based upon lower product costs. If the USA cannot compete on lower costs, then maybe we could be competitive internationally through other areas such as superior technology, as the USA did to win WWII and for a couple of decades following WWII, but the USA is no longer the World Technology leader that the USA was until maybe the 1970’s. Asian countries are now are the technology leaders. The best & brightest students in the USA have pursued the more financially rewarding non-scientific financial careers, instead of educations that might have created technically innovative products that people in foreign countries might purchase.
October 20th, 2009 at 9:26 pm
The USA must create superior engineers, superior medical doctors, dentists, and scientists so that we can regain the technological edge that the USA has lost and purposefully destroyed in the last few decades. This will not be easy, but it must be accomplished immediately before it is too late. Resources should be spent on regaining the technological edge, rather than paying borrowed government money for buying Wall Street toxic assets and US government pork barrel expenses.
We must somehow create funds to finance the re-creation of a superior Human Technical Base that is required to win any technology war.
We need to reverse course of our educational system and re-emphasize science and engineering to create many more medical doctors, engineers, scientists, and educators as the educational system did prior to the 1970’s. The USA scientists, medical doctors, engineers, and educators must also become much better educated, much more intelligent, and otherwise much more superior to any foreign educated engineer and/or scientist in order to design, create, innovate, and produce new technical products that foreigners do not have, so that the foreigners will then buy these new products from the USA, in exchange for their foreign gold and US currency which could then be sent to the USA companies.
Only if our future products are technically superior can we export those products in return for their foreign payment (gold and US dollars) to the USA, unless we can somehow produce these products cheaper than the foreigners. We must also prevent foreign countries from pirating and/or copying our new innovative products. We might need to use the force of law and/or the force of our military might to prevent any pirating of our technology.
October 20th, 2009 at 9:31 pm
If you visit the Texas Medical Center (mostly the MD Anderson Cancer Center in Houston) and witness the percentage of women wearing Burkas, you can get a clue or an estimate of the percentage of foreign medical service income currency that is received at the Texas Medical Center. I do not believe that any of these women wearing Burkas are US citizens. Foreign currency paid to our US located Medical Doctors, Laboratories and Hospitals improves our foreign trade balance. I think that most foreigners believe that US educated medical doctors are still much superior to their own in-country educated medical doctors, and that is the reason that they seek the best medical care available which is in the USA. We must maintain the US leadership in the medical field.
Our computer programming technology and expertise (ala Microsoft etc.) helped our balance of payments considerably in the past, but the lack of technical education in this country today has reduced and will soon totally destroy this export capability. The foreign countries have become better than the USA at creating new computer software programs, since the USA has chosen to de-emphasize technical and scientific education in our universities. Asian Countries are now the producers of new computer technology, not the USA.
Engineers who are working in Foreign Countries and sending (most of) their dollars home to the USA improves our balance of trade. In the past, foreigners believed that US educated and trained Engineers were superior to their in-country educated Engineers. This advantage has almost disappeared since the USA stopped emphasizing engineering education, science education, and other technical education in our Universities. I have been the engineer of record for the construction of projects in Asia, Europe, Middle East, Caribbean, and South America. US citizens are unaware of the lifestyle advantage that we are accustomed to and take for granted. If our economy collapses, we can become a starving third world country overnight.
October 26th, 2009 at 2:04 pm
Sorry Dean but the idea that “A lower-valued dollar would also make our exports cheaper in China. That would allow us to export more to China.” is not true.
In a perfect world this is what would happen. As history has shown though, mercantilist’s have many means to continue to distort trade. Has Japan ever become a large importer from the US (rhetorical).
It appears that balanced trade is something that can only happen by force.