Sunday, December 16, 2007

The Chinese Debt Threat

My good friend Dave left a thoughtful comment on my Faux-live blogging the Iowa Debate post (which I'm surprised anyone actually took the time to read because it was so obnoxiously long). In replying to his comment, I quickly realized I was writing a blog post, not a comment - so here's my reply in the form a brand new post.

Dave took issue with how dismissive I was per the size the US national debt, and the amount of danger that said debt puts us in. Here's his comment in full:


I disagree with you on the National Debt.

The debt that is owed to other countries could really hurt us in the long run. If China really wanted to screw us, all they have to do is sell off the dollar and convert it into other currency. That would trash the value of the dollar and led to unprecedented inflation.

Also, the idea that we can just "not pay back" the debt would be met with international opposition on a massive economic scale. This could lead to heavy tariffs and barriers being put up against the US and destroy free trade. This would led to staggering inflation, good shortages, and a vast economic decline.

At a minimum, China's dictatorship could act unilaterally by blocking all trade. This would led to a huge trade problem with the US. Though China might be hurt worse, they have the political will to take the heat. The American people would not accept the heat...we're pansies. Just look at the Iraq war and why we're "losing."


His position is a common one, and I think is probably the position held by most Republicans, including (I think) all the current Republican presidential candidates.

But it's a topic where my inner-free-trade-libertarian rules the day for me by way of economic philosophy.

I don't worry about damage foreign nations could do to by virtue of their owning some chunk of our national debt because in order for a foreign nation to execute that damage against us, they would need to do a comparable amount of damage to themselves.

Suppose I own 20% of some major public company's stock. I can (temporarily) hurt that company by doing a massive sudden sell off of my stock, but it's going to screw me over too.

Similarly, if China suddenly sells off the dollar-denominated assets they hold (in an effort to decrease the value of the dollar, to harm us), they are going to lose a lot of wealth because, by definition, they'll be selling those dollars off for low values.

Furthermore, as I understand it, China only holds about 4-5% of our debt [1]. That could cause noticeable harm, but would hardly be catastrophic.

Moving to the possibility of China cutting off all trade, trade with China makes up about 13% [2] of our trade, and 11% [3] of their trade. That's more significant than 4%, but I think 13% is recoverable, and as much as it would hurt us to have 13% of our trade blocked off, I can not see a scenario where China would be willing to inflict that harm to us at the cost of 11% of it's own trade.

To quote the Wikipedia article on the (military) theory of mutual assured destruction, "the payoff of this doctrine is expected to be a tense but stable peace".

Finally, on the notion that our refusal to pay back huge chunks of the debt we owe China would result in world wide outrage. I grant this is true, but my counter is that to the extent this is true, I assert that there would be an equal amount of international opposition/outrage if China tried to destroy the dollar or the US economy.

For some more thoughts in a similar vein to mine, but probably better thought out and written, I'll refer (yet again) to a Cafe Hayek blog post by Don Boudreaux: "Should Americans Worry About Foreign-Government Holdings of Dollar-Denominated Assets?".

Boudreaux and I both agree that question is best answered with "probably not."

5 comments:

David J Boehm said...

A couple comments in response to your post:

Your idea of MAD economics is based upon the idea that China's all-powerful government is rational. But does not absolute power corrupt absolutely?

China selling off dollars would cause the dropping value of the dollar because it signals a major economic power having distrust in our currency. Massive Sell-offs of the dollar = low demand and high supply in international monetary markets.

If the U.S. refused to pay back debt and China called the US on it, the international community would be in a rage about our refusal. Though some might be peeved at the Chinese, America never gets the benefit of the doubt. China would and the majority of the international community would side with them.

What about the spiritual, emotionally, moral, ethical implications of our debt? We are the richest country in the world and yet we still need to borrow just to make our annual budget. Does this signal a strong economy, or a rich spoiled brat spending more then he makes?

If the U.S. continues to borrow, the end result will be bankruptcy (refusal to pay back loans and complete cancellation of debts). Then no one will trust the US government in financial and monetary markets and massive trade and monetary barriers would ensue. This would trash the economy.



My grandpa always taught me to spend less then I make, don't take out loans, and if you do take out loans to be a respectable borrower.

Ethically, I as an American am sick of the whining over the lack of money we have. As the richest nation in the world's history, I am appalled that we continue to borrow or would even think about defaulting on our debts.



"Spend less then you make."
"The borrower is slave to the lender."
"Where your money is, your heart will be also."

As Americans, lets finally be respectable in the international community and quit borrowing from our less fortunate neighbors.

Just think, are we the Paris Hilton's of the international community? No wonder everyone hates us!

David J Boehm said...

I don't want to be confusing. But my main concern is not China. Its the government and people's financial policies in general.

To Understand more, read my post on this subject.

http://polichristian.blogspot.com/2007/10/economic-unrest-political-unrest.html

kazoolist said...

Some comments in reply. (And, this back and forth is a lot of fun.) I wish Blogger would allow the use of the <blockquote> tag in comments... since it doesn't, I'll be putting my quotes of your comments in italics.

In reply to your first comment:

Your idea of MAD economics is based upon the idea that China's all-powerful government is rational. But does not absolute power corrupt absolutely?

Not to mince words, but it really only requires China to be rational in-so-much that they won't be willing to dramatically harm themselves in an effort to harm the U.S.. And, I see no reason to suspect this is not the case. I don't think China is absolutely powerful, nor do I think what power they do have will cause them to act against their interest in not doing themselves harm.

China selling off dollars would cause the dropping value of the dollar because it signals a major economic power having distrust in our currency. Massive Sell-offs of the dollar = low demand and high supply in international monetary markets.

Agreed, although it's true at even more base market principle. A mass sell off of anything (currency or otherwise) floods them market with supply. And, it's this concept that led me to my remark "Similarly, if China suddenly sells off the dollar-denominated assets they hold (in an effort to decrease the value of the dollar, to harm us), they are going to lose a lot of wealth because, by definition, they'll be selling those dollars off for low values" in my post.

If the U.S. refused to pay back debt and China called the US on it, the international community would be in a rage about our refusal. Though some might be peeved at the Chinese, America never gets the benefit of the doubt. China would and the majority of the international community would side with them.

If China did a massive sell off of dollar enumerated assets, it would affect every other counry with a significant amount of dollar enumerated assets. You can be sure that Japan, who owns an even bigger chunk of our national debt (see this chart) would be outraged.

What about the spiritual, emotionally, moral, ethical implications of our debt? We are the richest country in the world and yet we still need to borrow just to make our annual budget. Does this signal a strong economy, or a rich spoiled brat spending more then he makes?

If the U.S. continues to borrow, the end result will be bankruptcy (refusal to pay back loans and complete cancellation of debts). Then no one will trust the US government in financial and monetary markets and massive trade and monetary barriers would ensue. This would trash the economy.

My grandpa always taught me to spend less then I make, don't take out loans, and if you do take out loans to be a respectable borrower.


This is the last block-quote I'm going to directly respond to, because I think my response here will also be pertinent to the remainder of your first comment to my post, as well as your post that you referenced in your second comment.

First, I think we are in agreement that we'd both like to see the level of government spending go down. I can not agree more with you that the ability for an elected official to provide benefits to his constituents using borrowed money leads to disaster. The incentive becomes for the elected official to give as much as possilbe to the electorate and pass the cost off to future generations.

I also agree that Americans as individuals are spending beyond their means, and that's a problem. I think we both long for a nation of individuals who find thier fulfillment in knowing Christ and have no need to try to spend their way to happiness.

Where I think we disagree is the degree to which government debt and personal debt are equivilant... or, maybe put another way, should the government follow the advice of Dave Ramsey.

Let's look at it in terms of a year with a surplus. If an individual was carrying debt and had a year in which income exceeded expenses, Ramsey, in accordance with "live like no one else today, so you can live like no one else tomorrow", would, I'm sure, advise putting the entire surplus towards paying off the debt. And, I think that's good advice.

Now let's examine what a government in the same situation could do.

I count four options: 1.) Save it (invest it), 2.) Return the surplus tax revenue to the American people, 3.) Spend it on new programs, 4.) Pay off debt.

Paying down the debt isn't a bad option, but doing so carries the opportunity cost of not doing the other three.

Consider a citizen carrying significant credit card debt, say at 20% APR. If the government chooses returning the surplus, this individual will have to pay higher taxes later on (to cover the about 6% APR interest that the government's lenders charge for our government's debt) but paying those slightly higher taxes is more than offset by the money he can save by paying down his credit card with his refund check.

Likewise, returning a surplus generally helps stimulate the economy. I think Bush's doing this early in his presidency kept the economy afloat, despite the challenges of the Web 1.0 bubble burst and September 11th. And, what I think is a better measure than the absolute value of the debt, is the debt as a percent of GDP. Right now that that percent is higher than I'd like, something like 70-80%, but there are two options to reduce that number. One, pay down the debt. Two, increase GDP. In the long run, I think the later (increasing GDP) is what benefits the U.S. more.

It's also worth noting that if the U.S. had no national debt, a lot of things we depend on would disappear. The Federal Reserve and monetary policy would have to change drastically, if they'd be sustainable at all. So would our current concept of currency. And, the ultra-secure investment of the U.S. Savings Bond would also disappear.

Boiling down all of the above, the preferred policy I'd like to see the government follow is:

- With maybe a careful exception of paying for things like war, stop taking on new debt, and do this by reducing government expenditures
- When faced with a surplus, always consider using the surplus to grow GDP rather than paying down the debt
- Don't worry too much about foreign ownership of the debt, especially if that ownership tracks like today's

David J Boehm said...

In response to your response to my response to you response to my response to your post...(Your quotes will be in quotes) (And yes, I enjoy back and forth sparring)

"Not to mince words, but it really only requires China to be rational in-so-much that they won't be willing to dramatically harm themselves in an effort to harm the U.S.. And, I see no reason to suspect this is not the case."

The fact is, we cannot keep using the term China to refer to what the Chinese response will be. In actuality, China is run by a group of Dictators who make all of the
decisions.



"I don't think China is absolutely powerful, nor do I think what power they do have will cause them to act against their interest in not doing themselves harm."

Again, this requires that dictators be rational. In their own self-interest, their dictators would love to be more powerful. But jerking the chain a little and attracting international attention and support would be a huge step forward for China and big step back for the United States.



"Agreed, although it's true at even more base market principle. A mass sell off of anything (currency or otherwise) floods them market with supply. And, it's this concept that led me to my remark 'Similarly, if China suddenly sells off the dollar-denominated assets they hold (in an effort to decrease the value of the dollar, to harm us), they are going to lose a lot of wealth because, by definition, they'll be selling those dollars off for low values' in my post."

Think about what would cause the sell-off of the dollar and therefore the price drop...the Chinese action of selling dollars. Therefore, the Chinese would gain today's market value for the dollar, and THEN the dollar's value would plummet and other currencies rise...currencies the Chinese would then have.





"If China did a massive sell off of dollar enumerated assets, it would affect every other counry with a significant amount of dollar enumerated assets. You can be sure that Japan, who owns an even bigger chunk of our national debt (see this chart) would be outraged."

The Chinese hate the Japanese as they have alway been at odds. In addition, there would be little international sympathy for Japan or the UK as they are considered US sell outs.




"First, I think we are in agreement that we'd both like to see the level of government spending go down. I can not agree more with you that the ability for an elected official to provide benefits to his constituents using borrowed money leads to disaster. The incentive becomes for the elected official to give as much as possilbe to the electorate and pass the cost off to future generations.

I also agree that Americans as individuals are spending beyond their means, and that's a problem. I think we both long for a nation of individuals who find thier fulfillment in knowing Christ and have no need to try to spend their way to happiness."


Here you agree with me that adding debt nationally and personally is bad. Good for us. We agree on this point. :-)



"Where I think we disagree is the degree to which government debt and personal debt are equivilant... or, maybe put another way, should the government follow the advice of Dave Ramsey."

I agree that they are not completely equivalent.



"Let's look at it in terms of a year with a surplus. If an individual was carrying debt and had a year in which income exceeded expenses, Ramsey, in accordance with "live like no one else today, so you can live like no one else tomorrow", would, I'm sure, advise putting the entire surplus towards paying off the debt. And, I think that's good advice."

That's also true. BTW, I rather enjoy Dave Ramsey and listen to his free podcasts daily. How are you? Better then I deserve!




"Now let's examine what a government in the same situation could do.

I count four options: 1.) Save it (invest it), 2.) Return the surplus tax revenue to the American people, 3.) Spend it on new programs, 4.) Pay off debt.

Paying down the debt isn't a bad option, but doing so carries the opportunity cost of not doing the other three."

Oh yes it does come at that cost. But saying, 'Man! I could hike up this hill so much faster if I would just take a little time to remove some of these rocks in my pack. But...that's time I could use to climb the hill! So, I'll just keep climbing.' Hmmm...I'd rather take the time now...



"Consider a citizen carrying significant credit card debt, say at 20% APR. If the government chooses returning the surplus, this individual will have to pay higher taxes later on (to cover the about 6% APR interest that the government's lenders charge for our government's debt) but paying those slightly higher taxes is more than offset by the money he can save by paying down his credit card with his refund check.

Likewise, returning a surplus generally helps stimulate the economy. I think Bush's doing this early in his presidency kept the economy afloat, despite the challenges of the Web 1.0 bubble burst and September 11th. And, what I think is a better measure than the absolute value of the debt, is the debt as a percent of GDP. Right now that that percent is higher than I'd like, something like 70-80%, but there are two options to reduce that number. One, pay down the debt. Two, increase GDP. In the long run, I think the later (increasing GDP) is what benefits the U.S. more."

Our economy is based on consumption of goods more and more. The market and even the government has encouraged us to consumer more and more and more to increase GDP. The average American works more then 50 hours a week, highest in the world. Is our quality of life really higher because of all the new "stuff" we can buy? Anxiety, depression, lack of relationships, a deteriorating family, and kids raised by Day Cares is now the norm.

You might argue that this is good as less are unemployed and poverty is being erased, but what does it mean for the individual when he's consuming on money he doesn't have? Isn't this a little reminiscent of the 1920's before the Great Depression?

My point in the end is, Joe Public will run up debt to an extreme regardless of taxes. The only question is when will he get to the end of the rope. Therefore, lowering taxes and keeping national debt only kicks the can down the road. And when we get to the point of massive personal bankruptcies, do we want to then lower taxes and have government programs that teach people personal finance skills? Or do we want to have "helped the economy" by increasing the short-term economy at the cost of long-term viability.




"It's also worth noting that if the U.S. had no national debt, a lot of things we depend on would disappear. The Federal Reserve and monetary policy would have to change drastically, if they'd be sustainable at all. So would our current concept of currency. And, the ultra-secure investment of the U.S. Savings Bond would also disappear."

I'm not overly worried about the structural consequences of no national debt. Personally, I think it would be a great problem to have. And as far as Savings bonds go...everyone knows they're a crappy investment. The U.S. could still offer that as it is a VERY small piece of national debt and invest the money in free markets.


"Boiling down all of the above, the preferred policy I'd like to see the government follow is:

- With maybe a careful exception of paying for things like war, stop taking on new debt, and do this by reducing government expenditures"

How do you quantify Wars? We currently take on less national debt per year then the costs of National Defense.



"- When faced with a surplus, always consider using the surplus to grow GDP rather than paying down the debt"

You can't just "grow the economy." And realistically, the U.S. only has a surplus in times of great prosperity (which we are in now with still a deficit). In these times, its actually good for the economy to slow it down so it doesn't burn out. This means a great way to slow down the economy for steady strong growth would be to...tax and pay debt off.


"- Don't worry too much about foreign ownership of the debt, especially if that ownership tracks like today's"

I'm not overly worried about who has our debt as much as the fact we keeping adding debt nationally and personally.

You can't tell me that the national debt shows a good example.



Imagine how scarey it would be if the U.S. took on some hard times for 10 years by paying off national and personal debt and arose with a fabulous economy and NO debt. Yikes! That sounds like a goal to me!

Imagine even scarier still: The U.S. government not only pays off debt, but then begins to build surplus money into an investment fund that would off set tax needs. A self-sufficient government and NO taxes?? Now I really am dreaming!!

David J Boehm said...

Interesting...

If the U.S. Government pulled $500 billion a year and invested it in the market for 8% for 20 years, the government would have $27 trillion in assets. Alittle more aggressively at 12% the government would have 48 Trillion in investments. If we stopped the pay in at 5 years, we would still have $26 trillion dollars.

From the $26 Trillion, the government could keep up with inflation and spend $2.158 Trillon with no taxes.

I guess the problem is finding the place to invest $26 Trillion in mutual funds...

Imagine economic expansion with no taxes