The Chinese control vast amounts of US Bonds and have nearly a trillion in US Dollars in their reserves, sounds scary huh? It's not. One trillion
dollars is a drop in the bucket that will be absorbed by the global traders in no time and basically forgotten.
The SEVERE risk comes from the Chinese changing policy
on their "Forex" buying. The Chinese have held up much of the US Bond market for the
past decade or so. Let's step through this scenario...
If the Chinese just quit buying US T-Bills; long term, 30 year notes, mid term 10 year notes and short term 5 or less year notes, the immediate impact
on the US economy will be harsh.
The "price" of bonds (a percentage above or below "par" or face value) runs inverse of their yield. If someone pays 103% for a bond, the yield on
that bond will be less than if they paid 99% of par for it. The yield directly impact the interest rates of virtually EVERYTHING.
If China gets out of the US Bond market in a significant way, there will be much less bidding on Bond offerings and the prices could very well decline
thus causing the yield to rise. A rising yield is a rising interest rate.
Rising interest rates are US Economy KILLERS unless the economy is "too hot", growing faster than the system can sustain (way more demand than
supply), then rising interest rates are a good, not a great, balance mechanism. Raise rates (ala the Fed with their "rate hikes) and slow the economy
to a more manageable rate of growth and stave off inflation.
The current US Economic picture is NOT one of solid, sustainable, industrial growth IMHO right now. This is very important because fast rising
interest rates in this situation are guaranteed stifle and maybe crush the fragile growth we have right now.
The CONSUMER. Finally we arrive at the real US Economy, the good old Consumer, YOU and ME.
When I read all the convoluted analysis of the current US economic outlook I often wonder what planet some of these "economists" are working from.
The bottom line, way over simplified reality of the US economy right now
is that the engine of growth, the Consumer (you and me), is in debt up
to his/her eyeballs. That's nothing new for the US and normally wouldn't be a big deal. The dangerous part of today's situation is the type
of debt we all are buried under. Interest rate sensitive debt.
Anyone with a variable rate mortgage for example stands to get creamed by China dropping out of the US Bond market. Bond yields go up, interest rates
go up, your house payment goes up. There are caps on how much the rate can increase on a variable rate mortgage, usually 6% a year.
That can add
many hundreds of dollars a month to one's housing costs. That takes those hundreds OUT of the economy.
The economists who keep lauding the "growth" of the US economy make me nervous. The "growth" is nothing more than people going into debt and
buying products that will wear out. There is a limit on how much debt we can incur isn't there? Maybe not. But if there is we are getting close to it
and any negative influences can tip the boat over pretty easily.
The typical follow through for the US economy once the consumer is worn out (slows spending dramatically) is industry. Industry has historically
picked the ball up and carried the economy until the next big consumer spending cycle. Industry will be hard pressed to do this now. With a double
whammy of higher debt service and lower sales to a worn out consumer the picture gets bleak fast.
The weaker US Dollar will hurt China without question, China has been buying US Bonds for this very reason, to keep the dollar strong and able to buy
lots of Chinese produce. The real question is going to be is China in a position to take that hit? Maybe.
The "strong US Dollar means more exports from the US and therefor more economic growth for the US" concept is long dead. What, exactly are we going
to export? We have shipped our manufacturing base over seas or lost it completely in many industries to cheaper competitors.
The US is in a transition phase IMHO. We are going to have to find the way to lead with innovation and creation. We are going to have create NEW
industries that we can dominate globally and grow with. That's how we did it at the beginning of the industrial revolution. That's what made us the
powerhouse we are today.
The very fact our economy is exposed to calamity by a decision China may or may not make should be a WAKE UP CALL that we are not in a good space
economically. The short
view management tactics (grab the cash today by selling bonds) are going to catch up with us in the long
Interest rates are crucial to our economy and we have sold way too much paper debt (bonds) to foreign governments, we have incurred way to much debt
individually (credit card and real estate debt) and now are faced with China having the ability to single handedly impact our interest rates for a
while at least. Is this a good economic strategy?
Time will tell if this economy is going to tank or slide by. I personally believe we will take a pretty good hit in the next 1-3 years
something like China bailing out of the bond market happens. If it doesn't happen then it's any body's guess. We've never seen
times like these.
All this and we still have "terrorism" threatening our economy to boot!
[edit on 1-7-2006 by Springer]