Stand Up Economics (6-6-09)

I get by with a little help from my friends.

On his first official visit to China, the biggest foreign investor in US treasury bonds. Treasury Secretary Tim Geithner, in a speech at Beijing University, attempted to reassure his Chinese hosts that its huge holdings of dollar assets are safe and reaffirmed his faith in a strong U.S. currency. Ahead of meetings with President Hu Jintao and Premier Wen Jiabao, he said the US and China must work together to fix the global economic system. His attempt to calm concerns that the Obama administration's bulging budget deficit and ultra-loose monetary policy will fan inflation, undermining both the dollar and U.S. bonds, was met with a response rarely found in economic circles. After answering a post-speech question, where he stated “Chinese financial assets are very safe”, university students attending, responded with ridicule and derisive laughter.
Mr Geithner also said the US would move swiftly to get its debt under control.

This was followed by several Chinese university students rolling in the isles, yelling "staa...staa... befo-we-pee aaseves." (just kidding)

Geithner Faces a Tough Challenge to Win Round Skeptical China. Why are the Chinese skeptical? Emerging economies such as China and Russia had been calling for alternatives to the dollar as a reserve currency. The concern is the US Federal Reserve's policy of expanding the money supply to prop up the banking system. Because the magnitude of the bad assets within the banking system. The Fed has been forced to pump massive amounts of freshly printed money into the system, which will eventually trigger high inflation or even hyperinflation and cause great damage to the countries that hold dollar assets in their foreign exchange reserves.

Are the Chinese just trying to increase leverage in the midst of ongoing negotiations? Or do the Chinese really have reason for concern? China is the biggest foreign owner of U.S. Treasury bonds. U.S. data shows they have $770 billion invested in US treasuries, a class of US government debt, but some analysts believe China's total U.S. dollar-denominated investments could be twice as high. As investors in our country, the Chinese have seen numerous contract violations, the erosion of property rights, the devaluing of the dollar, and a major investor (Bill Gross) questioning our sovereign creditworthiness. Moody's Vice President Steven Hess said Wednesday that while the U.S. government's debt rating is stable now, a reassessment of the economy and the government's debt could put "negative pressure on the rating in the future."

Against that backdrop, Secretary Geithner’s vows of future fiscal prudence and discipline currently ring quite hollow. Truth is, The huge expansion of US debt will finally call into question whether the government can continue to pay the interest. With trillions of dollars of T-bonds already held worldwide, in order to sell more bonds, the US government will have to entice investors with higher interest payouts. Lenders will not buy more bonds unless the rate of return is high enough to offset their risk. By 2016, the federal government may well be borrowing two trillion dollars per year, one trillion of which will be needed to pay the interest on our $20 trillion debt. There will be strong temptation for the Federal Reserve to monetize the debt (buy treasury bonds). The vast increase in the money supply will offset the higher interest rates caused by the huge diversion of investment funds to US debt, but will then spark much higher price inflation. It will be a financial earthquake in the global financial system that will bring on a world-wide economic crash like never before imagined. The US government will again be bailing out the financial system, mortgage lenders and borrowers, and massive payouts will need to be made to the mob of unemployed citizens. The risk and inflation premiums on T-bonds will become so high that the treasury will have little choice but to declare a temporary postponement of the interest payments. This will then segue into a default.

Now, I've been quoted several times stating that Obama's money men; larry, tim and peter (No! They don't deserve caps!) are among the dumbest economists on the planet, after christina romer (an economic historian?!). And, I've railed against the slush fund economic recovery plan, the unbelievably irresponsible budget proposal, and just about every economic plan that they have made public thus far. But somehow, even I, seem to get a little steamed when Chinese students laugh at our government secretary. Now, I'm not defending the guy. I think he's totally insane! But it's O.K. for me to say this. I pay his salary! The Chinese need to learn how to play well with others. This attempt to humiliate an official of the American government offends me more that the fact we need them to finance the United States Socialist Republic (U.S.S.R.). China ought to be less worried about inflation in the United States devaluing the dollar and more concerned about currency losses if the United States becomes a less friendly export market. Sure, we need them...But they need us. I find myself wondering if they know the fable "The Scorpion and the Frog". I also wonder, which of us is the scorpion, and which is the frog.