Why you should be worried too.
In my article, ColorComments Breaks with Obama, I wrote, “Whatever the immediate result, the long term result of blasting trillions of dollars into the economy mainly through more debt will be a crushing inflation that will make the present Bush Depression (note the capitalization – I’m proposing an official title) seem like a walk in the park.”
I haven’t changed my mind. (I have changed my mind about the next paragraph in that article, however. I’ll write about that in a future article.)
The news today is full of comments by Chinese Premier Wen Jiabao that China is worried about its vast United States treasury holdings. And they should be. The evaporation of more billions of dollars through punch number two of a one-two punch is just about to happen.
But none other than the Wall Street Journal has smugly claimed that worrying about it is, “about all they can do.” Ummmmm … No. China can do a lot more. And they will. (It’s sad to see the decay of a once great newspaper since Rupert Murdoch, the Genghis Khan of the news business, bought them out last year.)
Here’s how it will happen.
The inflation that is just now starting to poke it’s ugly head up will be a result of the government pumping trillions of dollars into the US and world economy. That money is created in two ways: simply printing more money and going deeper into debt. More money creates inflation because there are more dollars to buy the same goods and services (or … in a failing economy … even fewer goods and services). The debt creates inflation because the government will have to pay higher and higher interest rates to attract investors. And if they get worried, as China is now doing, that trend takes off like a rocket.
The Wall Street Journal claims China has no choice because, “it would scarcely be able to dump (their Treasurey holdings) in large blocks. And a partial selloff would surely lead to a slump in the Treasury market, eroding the remaining value of China’s portfolio.”
True. But the WSJ doesn’t take into account a third option. China could, and probably will, just stop throwing good money after bad. The US has to continually refinance their debt and sell new debt. So far, China keeps buying it. All they have to do is stop and buy something else. Third world investments come to mind. For example, Chinese money is moving more and more money into Africa by buying assets and bankrolling governments like Sudan. The Euro is another option China didn’t have a few years ago.
But the WSJ is right in predicting that this will lead to a slump in the Treasury market. In terms that you and I understand, that’s inflation.
Let’s get back to that one-two punch. Punch one was the evaporation of your savings through the collapse of the stock and real estate market together. Your house isn’t worth what it was and neither is your 401K. So people got out of those horrible investments and put their money somewhere safe. Like Treasury bonds? Punch two will be an inflation that evaporates the buying power of whatever you have left. Get ready to buy a dozen eggs for ten or twenty dollars.
What can you do about it except worry? Actually, there is something. Buy stocks and real estate. They’re cheap now and in a classic inflationary spiral, they’re about the only thing that might go up again.
I generally agree with your assessment. However, I think your option three is actually option four.
Option three is for China to continue to buy US debt but just demand a higher interest rate to compensate them for higher risk.
You might add another option as well – China could demand collateral for its loans to the US. How about all our Navy vessels and Navy and Air Force aircraft?
Given the current political makeup and climate in Washington I do not see any way to avoid a nasty period of high inflation. Congress will want to throw more money at perceived problems because that is what they do. (Fish gotta swim, birds gotta fly)
If the economic pundits are right the bulk of the stimulus package will flood into the economy about the time the economy is recovering on its own. That means high inflation.
Obama recognizes this danger and has said if it looks like that is what is going to happen he will start pulling stimulus money back out of future budgets. Sounds reasonable, but I doubt if Congress will go along with him. Every nickel of those trillions of dollars has a constituents name attached to it and Congress is not in the business of taking money from constituents unless it is in the form of taxes.
If the anti-market crowd is still in control in Washington when inflation really starts to bite you can expect to see some type of price controls.
“Option three is for China to continue to buy US debt but just demand a higher interest rate to compensate them for higher risk.”
Ummm … no. Option 3 is option 3 because the rate is set by the market – even where China is concerned. But it will be higher … that was a major point of the article.
“China could demand collateral …”
Treasury obligations are guaranteed by “the full faith and credit of the United States”. Since nations are “soverign,” there’s no way (well … no way short of warfare … which is sometimes used) to enforce repayment of debt other than the promise that’s already there.
“If the anti-market crowd is still in control …”
You are addressing one of that crowd, Sir!
The “market” is not a solution for all problems, but “faith” in the market has become a religion in the US. (“Faith” is belief without evidence.) What we need is a more open minded attitude about finding blended solutions that actually work.
Price controls are one way, but there is good recognition and understanding today of the limitations and problems associated with them since they have been tried, and have largely failed, over and over in history.
There are other ways of attacking the problem and I would hope that an Obama administration would not be tied down by political dogma as the previous administration was and will seek more creative and effective solutions.
perhaps were are talking past one another
the market sets the interest rate — even for the Chinese
yes — but selling of Treasury obligations is essentially an auction
The Chinese — or anyone else — will bid based on the return they want and if they don’t get it they don’t buy
If Chinese buyers are the market, they will decide the interest rate