Posts Tagged ‘US Treasuries’

Is China’s pump priming bad for the US?

Tuesday, November 11th, 2008

Yesterday, China announced a US$586 billion stimulus plan. That stimulus will be used mainly for infrastructure and social welfare. Some of this big money (US$29 billion) will come from government borrowing (see China’s Bond Sales to Increase on Stimulus Package (Update1)). It is not clear how much of that US$586 billion are new and additional spending on top of the existing pump priming already earmarked. Since this is just an announcement, the devil is still in the details.

The stock markets in Asia and Europe were ignited after the announcement. But the US stock markets did not share that enthusiasm. America does not have much to rejoice for. Why?

The reason is because China’s stimulus is hardly good news for America. To know why, you have to understand a couple of important differences between American and Chinese government spending:

  1. So far, most of the billions of dollars of American government spending go to bailouts. Every dollar that is spent on bailouts and rescues will be a dollar not be spent on rebuilding and maintaining the existing decaying and aging infrastructures in the nation. For China, apart from social welfare and tax benefits, the money will be spent on building new infrastructure.
  2. The US is already a colossally indebted nation (see How is the US going to repay its national debt?). They have to borrow or print even more big money for non-productive purposes. China, on the other hand, is the world’s largest creditor nation. They can easily finance all the big money with cash (figuratively). All these big monies are spent on more productive purposes (definitely more productive than bailouts and rescues).

So, since the Chinese government is flushed with ‘cash,’ where is the ‘cash’ going to come from? As we said before in Why did the foreigners bail out cash-starved financial institutions?,

China?s trillions of US dollars reserve is a form of savings that will be used to acquire their future needs for resources to power their economy in the long term.

Most of China’s US dollar reserve exists in the form of US Treasuries. Currently, the US Treasury bond market is the last bubble that is yet to burst. Along with that, with the collapsing commodity prices over the past few months, every Chinese US dollar reserve is worth even more (i.e. every US dollar that China has can buy more commodities then before).

The implications for the US are grim:

  1. The US government can forget about borrowing from China for their bailout and stimulus spending. They have to either borrow from their private sector (which is in no mood to lend because it is drowning in US$41 trillion of debt itself) or print money.
  2. China has to either sell down its hoard of US Treasuries or at least slow down its pace of accumulation considerably. With the US consumers choking on too much debt, the leakage of US dollars to China (through the Current Account Deficit) will dry up. This means the back flow of US dollars back to the US via Treasury bonds purchases will dry up too (see Awash with cash?what to do with it? on how this works). This means long-term interest rates in the US will have to rise. Since US mortgage rates are largely derived from long-term interest rates, this will mean trouble for US mortgage borrowers.
  3. Chinese liquidation of US Treasuries is bad news for the US dollar. In fact, without foreign central banks’ accumulation of US Treasuries, the US dollar would have collapsed long ago.

The question is, will China be able or willing to engineer an orderly liquidation of US Treasuries?