Wen Speaks and the US Listens

We’re finally coming to the point where Chinese officials are starting to express their concerns openly about the money printing and the potential devaluation of the US currency:

Obama Tries to Reassure China

It was QUITE humorous to read this after seeing politicians comment for years on China manipulating its currency and giving China all of this tough talk – the problem with some of these old (and old-thinking) congressmen is that they think they’re a union boss in the 1950′s- their tough talk these days will get you a cup of coffee if you throw in 2 bucks with the talk.

Let’s summarize the issue shall we?

When we import goods from other currencies, we purchase those goods with dollars. China, being a major source of our imports, takes these dollars and needs to do something with them (can’t buy stuff in China with dollars) so they turn around and their central bank  buys US treasury debt with these dollars (can use US currency to buy US debt).

According to that article, China holds almost 700 billion dollars of US debt and this is growing. And Wen Jia Bo, the Chinese Premier is expressing his concerns that with all of this new spending & bailouts, the US government will not be able to sustain its debt load. And with approximately 1.2 trillion dollars of new debt being issued to fund all of the ADDITIONAL spending, there is real concern.

What is the concern?

The concern is that as fear grows about the US ability to repay this debt, buyers will demand higher rates to purchase the debt. Most people would agree that few would lend money at 2-4% for a LONG period of time (see current US Treasury rates HERE). Would you lend me money for 30 years at 3.67%? This is what the rest of the world is doing for us.

As inflation rises worldwide (due to demand for food and raw materials as the world develops) and public debt rises, creditors will demand higher rates. How? Buyers will simply not buy the US bonds unless the rate is increased – simple. China is worried that the US won’t pay or have trouble paying, hence the words from Premier Wen.

The Damage

If rates rise, it will have harmful effects on not only us but also our foreign creditors. According to noted investment advisor Peter Schiff, in a recent interview, he said we (USA) are financing an increasing amount of our debt with short term bonds instead of locking in long term rates. if rates spike our interest payments will spike. To put this in the worst possible light, 22% of our tax revenue goes to debt interest – if rates on the debt doubled (because the short term bonds will mature soon and new ones will be sold to pay back the old – basically government “refinancing”), assuming we didn’t add or subtract any debt, our interest payments would be 44% of tax revenue!!!!!

Not only would our interest expenses rise, but also it causes longer term bonds to lose value – China would see a current devaluation of their long term US government bond portfolio if rates were to rise quickly (they would sell these bonds to fund purchases of iron ore from Australia for example). If these bonds devalue, China can’t sell them for as much in a current market (as opposed to waiting for maturity) and can’t use that money to trade with others. they DON’T WANT THIS.

The US would like to keep printing money however (Treasury issues debt to fund all of the spending that George W. Obama just passed and the “independent” Federal Reserve Bank buys the debt with printed money to try to keep rates down). If they can print money without a rise in rates, they hope to solve all of our problems – basically solve our spending problems with…MORE spending! genius!

the crack addict gets no more money

Needless to say, China will worry and who knows, maybe TURN OFF the spicket. What would we do if no one bought our debt? It would be like how I described in my article on California’a budget crisis last month – emergency SHUT DOWN. if this happens, rates will SPIKE (can’t exaggerate that enough) and we wouldn’t have the money to run this country. THAT will be a real mess.

Chris Grande

3.13.09