China Will Not Unload Its US Government Bonds Because of the Debt Ceiling Crisis

31 July 2011

I thought I should write this while the debt ceiling debate is still raging. I want to make these statements before the matter is settled.

To begin, the debate over the ceiling is for real - it's not a charade. The Tea Party folks were elected to reign in US government spending. They aren't faking.

Further, let's say a deal is not reached by August 2. This would not necessarily mean that US government bonds would collapse in value. Continuing revenues could still be channelled to meet interest payments on US debt (which are presently only about 10% of US government expenditures - though solely because interest rates remain low).

Since the US prints its own money, it is well-known that the country cannot run out of cash (it can only run out of cash that has lasting value). This is unlike Greece, which shares the Euro as a currency along with the other members of the European Monetary Union. Greece cannot “print money,” but the US can.

However, there has been talk that the Chinese, who now hold something like $1.2 trillion in US debt instruments, could “foreclose” on the US, basically tanking the US currency and with it the US economy.

This argument misapprehends why the Chinese have accumulated $1.2 trillion US dollars in the first place.

If you want to understand this better, I recommend that you read an excellent article by a professor at Tsinghua University's School of Economics and Management in Beijing. In a very concise piece, Professor Patrick Chovanec makes clear why the current Chinese economic strategy not only requires China to keep its existing US government bonds, but in fact to continue buying more (though they are certainly diversifying).

Professor Chovanec states, "China’s growth model for the past 30 years relies, in large part, on running a trade surplus (selling more than it buys from abroad) in order to maximize capital accumulation and therefore investment at home. At the same it, it encourages inflows of foreign investment into China in order to speed up that process even further, while restricting Chinese money from flowing abroad, in all but a few controlled circumstances.

"The result is that foreign currency flows into China and piles up, with no outlet to flow back out again. Normally, all those excess dollars that were piling up in China would fall in value relative to the RMB, until the imbalances corrected themselves. However, in order to keep those imbalances in place, the Chinese government intervenes to buy up all those excess dollars (and euros, and yen) itself, to keep its currency from appreciating, and accumulates them as official reserves. It has to invest those reserves somewhere until it decides to use them to buy U.S. goods or make more direct investments with them abroad.

"Since the U.S. is China’s largest customer, and since many smaller customers also settle their international trade in U.S. dollars, roughly 70% of China’s $3 trillion reserves are in dollars. In theory, it could sell some of those dollars for other currencies or for commodities, like gold or oil, but in practice, given the huge sums they are already holding, its hard for China to sell off even some of its dollars without undermining the value of what it has left. Even if it could do that, there just aren’t any markets that are as large or liquid as the market for U.S. Treasuries, to accommodate the amounts of money we’re talking about. The fact is, as long as China wants to sell goods for dollars, and decides to accumulate those dollars as reserves rather than spending them on imports or investments, it has little choice not only to hold the Treasuries it already owns, but keep buying more and more."

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I'm not saying the US is not headed down the road to disaster. It is. Things have already gone too far. But the Chinese are not going to upset the applecart next week, whether the debt ceiling is raised, eliminated by presidential decree or maintained.

Click here for Prof. Chovanec’s article.

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Oh, just in case you thought that the Tea Party folks are really here to fix the problem, have a look at which party ran up the biggest tally of new Federal expenditures in US history:

I'm not calling Mr. Obama innocent. He has certainly been a big spender - but he has been no match for the George W. Bush Republicans! As they say, politics makes for strange bedfellows.

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Atlas Shrugged: The Movie Is Worth Seeing Despite Its Obvious Failures

15 April 2011

OK. Just caught the premiere of Atlas Shrugged: Part I this evening. I read the book in high school (at which time it was still fairly new - it was published in 1957). The movie is only on 200 screens.

In my view, Ayn Rand, the controversial and celebrated author, was not a great novelist. She used the form of the novel to express ideas about her personal philosophy ("objectivism") that had been formed by her personal survival of Russian collectivism and a genocide twice the scale of Hitler's. This woman definitely has something to say. As to the film, I was most struck by the conflicting and deeply compromised premises at its core.

Rather than seeing the film set in historical context, we find that it opens in the year 2016. Gas is $36 a gallon, everybody is unemployed, and evil politicians scheme to loot the last few of the country's wealthy and successful people.

Sound like Russia? You've got it. And we are also taken back to the original story of railroading, iron, steel and coal – and ballroom cocktail receptions. That is quite a disconnect, and at least for me, I couldn't set the railroad story in our present decade.

There are other problems. I was bugged by the characters' inability to construct grammatical sentences (“we/us,” “is/are,” basic stuff). The dialogue itself was probably taken from the book, but honestly, that is not an inspired source. Rand's characters can speak for 50 pages without taking a breath. So a lot of the pieces of the story didn't work together.

I also have the impression that the screenwriters (John Aglialoro and Brian Patrick O'Toole) don't know much about modern business. For example, and most tellingly, they stayed with Rand's notion that individuals would be outlawed from owning more than one company.

Hey, individuals don't own any major companies anymore – and don't want to! Everything has been floated on the market to exploit shareholders! Why do it yourself, when you can suck the shareholders dry?

This problem is in fact one of the contemporary manifestations of exactly the problem that Ms. Rand was trying to illustrate from the middle of another century.

That is, the evils of our age are different than those of the mid-20th century. So if we're going to set this story in 2016, then let's see the collective thinkers mired in political correctness and tortured compromises, trying to rescue the economy by destroying the currency. Hey! That is actually happening – and it would make the same point in a contemporary setting, as I think the screenwriters intended.

So, at least for me, this WAS still worth watching. I guess the producers didn't have much money or time. I understand. This is not a big budget film, and that's OK. Give them a break.

I think what everyone involved in this shoestring effort was trying to get across is that individual initiative is the only thing that can save us (as opposed, say, to organizing various factions into groups and going at each others' throats – as seems to occur on Fox News nightly!).

So yes, this film is trying to be about courageous people believing in something and doing it, not unlike trying to produce this film with no money! Good for them. It's probably still the right answer.... I commend them for trying!
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Fuel: By Josh Tickell

11 April 2011

I just watched the film "Fuel," on DVD, by my fellow New College of Florida alum, Josh Tickell.

This is basically the story of Josh's life's work. He has had an interesting life, and tells his story well. He happens to be a gifted environmental activist, plus a talented film maker.....

Josh majored in sustainable living at New College of Florida (yes, you can do that - that is, you are allowed to invent your own major, and this is what Josh did).

Basically, this film is about biodiesel. Biodiesel is not good. Biodiesel is revolutionary.

Biodiesel is NOT corn-based ethanol. It is not food-to-fuel. It returns the energy input 3:1 or better. It is safe and even edible. It pollutes less than so-called fossil-based diesel fuel. There are many ways to produce it, and more and better ways of doing it are being found all the time.

As an aside, the US can produce all the biodiesel it needs, and never has to import oil from anyplace again, if it chooses this path.

As Josh says, "War is not required."

Willie Nelson, Neil Young and Richard Branson are among biodiesel's better-known advocates.

Oh, and this film isn't only about biodiesel. It is also about how to live, how to conserve energy, the history of our present fossil fuel-based energy system, other ways to produce energy besides fossil fuels, the life story of Rudolph Diesel, a lot of Josh's own life story, interviews with scientists and business people, finance, educational graphics, statistical analysis, etc., etc. I hope you're getting the idea. My impression is that there are investible ideas here too, and why not?

Anyway, (1) you have to watch this to learn more, (2) you need to figure out how to get biodiesel and related sustainable technologies into your home, your life and your communities, and (3) you need to tell other people about this.

Again, this has nothing to do with corn-based ethanol, which is not a particularly good idea at all, at least, not much better than fossil fuels. This is entirely different. You can make this stuff from trees that grow to maturity in 3 years, from algae (thank Jimmy Carter for getting this started), from sewage sludge, etc., etc.

Again, the US does not need to import oil. Neither does any other country that wants to do this. This is good, very good.

Watch.
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Enantiodromia: The Word of the Day....

5 April 2011

The following is a comment I made on the Dollar Vigilante Blog. If a little more context will help you after reading this, then click here for Jeff Berwick's thought-provoking article ("Mortgaging Our Grandchildren's Future? That's Being Optimistic!"). In any case, my recent thoughts on enantiodromia:

Jung (the Swiss psychiatrist) used the term "enantiodromia" to describe the psychological principle of "running into opposites."

Historically, no people have ever been more opposed to centrally-planned, non-free-market economies than the citizens of the US. That, of course, has changed, and it is perhaps instructive to analyze why.

The healthcare system is one example.

Layers of bureaucracy and regulation have accreted over the years to PREVENT the emergence of government-provided healthcare in the US. The notion that government regulation can advance a free-market system has made the quasi-free-market health-insurance-encumbered US health system perhaps the most expensive in the world.

Like it or lump it, but government-run healthcare in Canada costs half as much, and for most people, it is also better.

Somewhere, the idea that the government and the Fed have the "responsibility" to rescue an economy in trouble became acceptable (our forefathers would not have accepted this idea for a moment), and the executives on Wall Street have been feeding at the publicly mis-regulated "private" trough for decades, making Animal Farm no longer an allegory (the pigs are running the farmyard).

A guy I respect (Bill Fleckenstein) says that the Fed (the US Federal Reserve Bank, headed by Ben Bernanke) has more implicit responsibility for this situation than any other body, including the big spenders in Washington and the over-leveraged risk-takers and game-players on Wall Street.

That is, easy money creates a climate in which elected representatives, business leaders, et al, simply believe they will be rescued.

And of course the public buys into this idea.

Who in Wisconsin is demonstrating in the streets, saying, "Hey, thanks for saving us taxpayers the money we can't afford to pay!"

Anyway, the greatest opponents of the centrally-planned economy have now morphed into its greatest advocates. Read more about it at the Dollar Vigilante....

Enantiodromia: the word of the day.....
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The Heroes of 2011: Japanese Nuclear Workers

2 April 2011

I've been following the New York Times Asia-Pacific page since the Japanese earthquake and tsunami.

I wish to make one point. We knew from the start that the reactors would leak as a consequence of the damage from both an earthquake and a tsunami. Come on, nothing is built to withstand such dual forces of destruction.

And yes, there is serious local leakage of very poisonous and persistent radioactive substances - plutonium, iodine, cesium and more, and they will spread. It's horrible.

But we must remember that (1) nothing nuclear blew up or (fully) melted down and (2) nothing nuclear burned.

Yes, it's disastrous, unimaginable, really. But it could have been far, far worse.

I give full credit to the courageous frontline workers, who knew from the start they would be over-exposed to life-threatening radiation.

They did this for us, and I thank them for their sacrifice on our behalf. When Time Magazine chooses the "person" of the year this year, I hope they remember these workers!
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My Question to Mr. Ignatieff

31 March 2011

On Sunday, April 3, at 11:00 am EST, The Liberal Party of Canada will host a special live town hall meeting that will be streamed online at Liberal.ca. During the event, Michael Ignatieff will unveil the Liberal Platform and answer questions from Canadians.

The Liberal Party is inviting Canadians to pose questions to Mr. Ignatieff.

I have responded by submitting my question. Honestly, I don't think my question is very easy, but here it is:

"Mr. Ignatieff,

"I regard our present time as the era of investor exploitation. Mr. Harper's dismantling of the income trust program selectively harmed small Canadian investors and sold off Canadian assets to international bidders. Low interest rates punish savers and motivate investors to take excessive risks or to misdirect investments. The broad markets have been flat for a decade. In the western world, only the Australians have a different (high interest rate) policy. Capital investment (saving) is at the heart of economic growth. Do you favour restoring the income trusts, raising interest rates, and undertaking other policies to benefit savers and to restrain high-risk (speculative) activity?"

Well, I'm hoping for an answer.....

I'll keep you posted.
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The End of Extend and Pretend

23 & 25 March 2011

As a subscriber to Bill Fleckenstein's bargain-priced financial advisory service, I have the privilege of popping off questions to Mr. Fleckenstein from time to time.

Tonight, I thought I had finally grasped the fundamental paradox facing the most indebted nation in world history.

Here is my latest question to Mr. Fleckenstein (who is taking a well-deserved day off tomorrow):
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Fleck,

Sorry to trouble you on a day off, but I have a simple question.

Let's say that there is no crisis and no "flash crash" between now and June 30, and that the Fed decides to halt QE (Federal Reserve money-printing) ad infinitum.

Given that the central bank will not be buying $75 billion per month in US treasury bonds, does that not mean that there will be MORE upward pressure on interest rates?

That is, QE = more money supply (inflation), but "No QE" means higher interest rates, and eventually higher federal debt payments?

(Note: a 7% rate on the existing $14 trillion plus US federal debt = $1 trillion in interest payments per year.)

And the fix is for our elected leaders to come back to us and say, "Sorry, we can't give you what we promised you after all. We're shutting off the tap. It's all over."

I think I'm truly beginning to grasp the Catch 22. Every option is "impossible," yet as in all paradoxes, and as always through history, the paradox will have to be navigated in real time.

If I've got it right, is there a timeframe (or interest rate level) beyond which extend and pretend is no longer sustainable?
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There it is. My latest question to Fleck. I'll share any answer that comes my way.....

25 March 2011: Mr Fleckenstein replied today to my question as follows: "In my opinion, austerity is a short sale, no one will stand for it, when we can just print money. I don't think there is any set level of anything that would end extend and pretend, it will end when it does, but I'd guess it will be 'unwinding' in the next 6-9 months or so."

Again, my advice for my readers is that you subscribe to Mr. Fleckenstein's economically-priced advisory service!
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Military-Industrial Malinvestment

21 March 2011

I wish I had time to say more on this topic, but for now, here is my quotation of the day, from my friend and adviser, Ed Bugos at the Dollar Vigilante website (I recommend that you join as a subscriber):

"If the world were on a gold standard, governments could not afford the wars they are involved in today, and there’d be no question of the West withdrawing from the Middle East, because we would not be able to afford it! If, instead of printing the money, the government said that it will increase taxes for everyone by $20,000 this year to fund their ongoing intervention in the Middle East in the name of democracy, there would be a lot less "Gotta Support The Troops" going around! Without the ability to print money, there’d be no military industrial complex."

- Ed Bugos, from The Dollar Vigilante Blog

In fact, I can say a little bit more on this subject, as I commented on Ed's post at the Dollar Vigilante site, as recapitulated below:

"OK. That was an interesting twist at the end. Where does the excess money printing end up? In the hands of terrorists, despots and dictators in the oil producing nations, and in the hands of the Military-Industrial Complex on our side of the pond! Now, you could write a book on military-industrial malinvestment!

"As to the crisis that produced Reagan and Thatcher, I suspect the next one will somehow be a blend of the 30s and the 70s, but I do not know which parts will figure into the final blend. Unfortunately, it will not be pretty, and it will be the direct result of money-printing!

"What I do know is that nobody will be calling, "The bottom is in! Buy real estate/stocks/whatever now!" The bottom will appear endless, and gold will be the ONLY bright light at that point...."

That's all for now, folks!

(Credit: The poster used above and the US dollar chart below came from this interesting article.)

(Disclaimer: The above comments are not directed at any particular military venture, some of which are needed in my view, but rather at the type of world that is created by printing money rather than paying our bills....)

Additional comment: Regarding the present intervention in Libya, the application of the above lesson runs something like this: (1) Money-printing (inflationary monetary policy) made oil expensive, enriching (and arming) such despotic leaders as Qaddafi. (2) We "solve" the problem with MORE money-printing, to pay for military interventions to protect the Libyan people from the ruthless leader whose ascendancy we funded in the first place! (3) The devastating consequences? We'll "solve" that with money-printing yet again! I hope you can see where this is going.... The cycle continues literally until the currency reaches the point of inflationary collapse. Then, hopefully at least for a while, we learn to live within our means again!
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Why US Health Care Doesn't Work

22 November 2010

Some things are so obvious, they shouldn't require explaining. Yet somehow, we seem to make simple things so complicated that we abandon common sense.

An example of this is health care.

In essence, government-sponsored health care works in Canada. All Canadians have a right to health care. It is not cheap, nor perfect, but it is affordable. Our government is not going to go broke over this issue.

Any Canadian can tell you that we have universal health care because of the "greatest Canadian," Tommy Douglas (Kiefer Sutherland's grandfather, if that helps the younger folks).

The Canadian system can be diagrammed simply, as follows:

GOVERNMENT

PHYSICIAN

PATIENT

There, that was simple, wasn't it?

Want to know why US health care is expensive, inequitable and unwieldy?

Check out this diagram:

Or this one:

The Americans are so afraid of government involvement in health-care provision that they have created an unwieldy mechanism to flow funds and services into and around the health-care system. Most of it doesn't get to where it needs to go. It is a disaster.

Wealth is created by the free market. Let's keep government out of it as much as possible. However, infrastructure - and the rule of law - are best managed by government.

Health care is infrastructure. It is not a market commodity.

There, wasn't that simple?

My suggestion.... Bring the Canadians down. They'll have the US system working in a year or two!

No more Rube Goldberg health care in the US!
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"Dear Uncle Sucker" - You Gotta Read This

19 November 2010

Barry Ritholz has written a brilliant piece of analytical satire - a parody of Warren Buffet's recent "Dear Uncle Sam" ("Pretty Good for Government Work") letter.

Go here now and read it - "Dear Uncle Sucker" - wow! That was concise!

Honestly, Mr. Ritholtz has dug much deeper than Mr. Buffett on this particular issue....
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What Is the "Funding Crisis?" (My Contest Entry)

18 November 2010

I have entered a contest....

From Bill Fleckenstein's November 18, 2010 “Ask Fleck" column:

Reader question: Hi, You often mention a funding crisis. I looked it up on search and there are so many references. Could you please define what is a funding crisis???

Fleck replies: OK... let's have some fun with this. I have been describing the future funding crisis since early 2009, so rather than me do it one more time, let's make this a contest. The reader who does the best job will get a free one year subscription, and we will place that definition in “Fleckisms.” The deadline for entries will be this Friday.

OK. Here is my go at that one-year free subscription.

What is the “funding crisis?”

Let’s begin with two basic principles:

1. Any entity that spends money must also receive money to fund its expenditures.

2. There are two ways around this – credit and money creation (both temporary fixes).

What entities spend money and thus require revenues?

Basically all entities.

What entities have been spending too much money?

Basically, most of the above, but particularly the western nations and Japan, which have aging populations that have access to government-funded entitlements and require more of same, specifically health care and pension funds. Also – individuals and corporations in “bubble” sectors have been over-spending, often on the “wrong” things, such as overly lavish homes and productive capacity for items for which demand is not presently growing (this is called capital misallocation).

Is credit fixing the problem?

Well, it seemed to be doing so for a while. But individuals have over-borrowed, and now have difficulty repaying what they borrowed, particularly if they have lost their jobs or have reduced incomes for other reasons.

As to nations, again the western nations have been borrowing like crazy by selling bonds, and those who are not borrowing (read Asian and/or BRIC nations) are loaning them the money they need for expenditures, that is “funding” the deficits, the most egregious of which is that of the US, with something like a real $2 trillion annual shortfall in revenues versus expenditures and entitlements (promised future expenditures).

Also borrowing (like crazy) have been state (California, Illinois, etc.) and municipal governments and individuals. Corporations in non-bubble sectors have been more “sane.” Basically, most all (western) individuals and agencies are maxed out on credit, with many reaching the point of inability to repay it. Thus, creditors are beginning to question the wisdom of loaning money to individuals and government entities that are unlikely to repay them, particularly as they can no longer re-sell (“pawn off”) loan portfolios to imprudent “investors.”

Enter money creation, also known as quantitative easing, presently in its “QE2” stage. Central banks print new money to buy government bonds, thus inflating (and devaluing) the money supply. When money printing (massive) exceeds economic growth (stagnant), you're in trouble.

Thus, we’re in trouble now.

Only national governments and monetary authorities (specifically the European Union) can in most cases print money. So long as everybody is doing it, you have “competitive devaluation,” and one currency doesn't rise or fall that much versus another. However, some players are so profligate that they have no foreseeable ability to repay borrowed funds without money-printing, and at some point lenders are going to look at the bigger picture and decide they do not wish to be repaid in a sharply devalued currency (also known as “play money” or “monopoly money”) in exchange for “real money” loaned today.

A crisis represents a sudden shift in sentiment and behaviour in recognition of a gradually evolving picture of the world as it is. When those who loan money (buy treasuries) decide that they are unlikely ever to be repaid with anything of value (“real money”), they simply stop providing the revenues (cash flow) for the big spenders, in the present case, particularly the United States and some profligate European counterparts (known as PIIGS).

When treasury buyers stop funding government debts by buying government bonds, the bonds decline in value (reduced demand combined with over-supply), and interest rates rise until they are high enough that somebody (the “next fool”) starts buying them. At this point, we will see the kickoff of escalating interest rates combined with rising consumer prices and declining incomes and revenues, ergo, “the funding crisis.”

That is, the big spenders no longer have funds flowing in to cover their expenditures, thus necessitating a radical readjustment in either expenditures (drastically reduced) or the value of money (grossly inflated).

Coming soon (perhaps), to a government and/or nation state near you!

22 November 2010:

The winners to the "funding crisis definition" contest are now in. Mr. Fleckenstein has chosen the following two (hopefully the reader will not find my "essay," above, to be far off the mark):

The best reader definitions

Winner

A funding crisis happens to a country when other nations or institutions believe that the value of its sovereign debt or the value of its currency will decline significantly over time due to poor fiscal or monetary policies.

When that happens, fewer and fewer people are willing to purchase the sovereign debt of that country, leading to a sharp increase in interest rates and greatly increased difficulty in the ability of that country to raise new debt.

A funding crisis thus refers to the inability of a country to finance itself without resorting to outright money printing. This can lead to a vicious cycle of currency depreciation, rising interest rates, poor economic performance and poor investor sentiment, all of which feed on each other in a downward spiral.

A funding crisis can only end when proper monetary and fiscal discipline is restored, usually at the expense of severe economic hardship.

This one earned a tie as it was almost as good AND he used the search so well

In gentle criticism to the Rap Reader who inspired this little exercise, it may be useful and prudent to read a majority of those “so many references” pertaining to the “Funding Crisis”. I searched “Funding Crisis” and read everything that had a score of over 25. In this review, I discovered you started describing the “Funding Crisis” in the middle of 2006, but you did not give it a ‘handle’ until late 2008. I am glad I participated in this exercise as I learned a great deal and have a more clear financial picture of where we have been, where we currently are and where we may be going.

A Funding Crisis: the successor to the financial and economic crises; created mainly as a result of Federal Reserve policy over the last twenty years. A funding crisis occurs due to a lack of credibility in the Federal Reserve (and, the United States) to instill confidence in the value of the US dollar and repayment of current and future liabilities. The result of a US funding crisis is: a declining value of the US dollar and rising interest rates in debt markets.

My advice - if you want to understand the present economic situation, particularly in the US, do subscribe to Mr. Fleckenstein's moderately priced web service.

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