Sunday, March 15, 2009


Now that Obama is close to getting a belated Christmas present in the form of a healthcare bill, you would hope that he would lighten up on his wish list and focus on doing something about the trillion dollar plus budget deficits that stretch as far as the eye can see. (Remember all the angst during the Reagan years about "100 billion dollar deficits as far as the eye can see"?) But no, his appetite for spending appears to be insatiable. Take the unused TARP funds (and he is more than happy to take them). Why not use that $200 billion to pay down the deficit? Instead, Obama wants to spend it on another stimulus bill in the guise of a "jobs program." And so the beat goes on.

I wonder what the Chinese are thinking, given that they are the ones who are lending most of the money for all these dreams and schemes.

They are probably thinking the same thing that your local banker would be thinking if you, Mr. Valued Customer, paid him a visit with a similar wish list but scaled down to your individual circumstances.

"Hi Dan," you say to your friendly "personal financial advisor" as you plop down into the cushy chair facing his fake Louis XV desk. You pluck one of the Jolly Roger candies from the little brass bowl on his desk.

"What's up, Mr. Valued Customer. What can I do for you today?"

"I'm looking for a loan, Danny." Apprehension fills his eyes.

"A loan, huh? What type of loan?" He quickly presses his tortoise-shell eye glasses against the bridge of his nose.

"Oh you know, just a personal, unsecured loan," you say as you suck on the hard candy.

"Ah huh...and what amount are you looking for?"

"I was thinking a million to start."

Dan gags and almost spews out his mouth the coffee that he just took a big sip of.

"A million dollars! For what?"

"Oh, you know, I was thinking about making an addition to my house, another 1500 square feet or so. I really need a place to hang out away from the wife and kids. Sort of my own personal Valhalla, if you know what I mean. A place where me and my buddies can do what we like to do, shoot pool, catch games, drink beer...guy stuff." You don't need to mention porn watching as one of those activities because you know that Dan gets your drift.

"And you think that addition will cost as much as a million dollars?" Dan asks with a tremulous voice.

"No, but I also had in mind putting in that swimming pool that Betsy's been bugging me about for ten years. Labor's cheap right now with the Great Recession and all. So I figured that now is as good a time as any to git her done."

"But Valued Customer, we already have a two million dollar mortgage on your house. And if we did an appraisal today on it, I'd be worried that the value doesn't even cover our mortgage."

"C'mon, Dan, I'm talking infrastructure! I'm improving my house and putting a lot of local workers to boot besides."

"I don't know, Valued Customer. Even if I thought we could make the loan, I still don't see how it would amount to a million dollars. I mean, you're talking about us increasing our exposure to you by 50% in one year."

"I didn't realize that you looked at me as something that you're exposed to, Dan," you say with a hint of indignation in order to put him on the defensive. "What am I, some kind of disease?"

"No but, you know..." Dan stammers. "So what else you got in mind with the money?" he asks to get back to the main subject.

"For some good purposes, Dan. Like healthcare. With medical costs running like they are, I figured that it might be smart to prepay the next 10 years of my family's out-of-pocket medical costs. Something wrong with that?"

"Nothing's wrong with that, I guess. It's just that you can't expect me to pay for it."

"And also you got a problem with education? Cause I wanna fund my 529 college funds up to the gills with the money that you are going to lend me"

Dan looks at you with a befuddled, sad expression, like he's wondering what caused you to totally go insane.

Could the Chinese be wondering the same thing about the collective mental health of our nation? We are basically proposing to double our national debt this year. Foreigners now own over half of that debt outstanding and the Chinese own the largest percentage of foreign held debt. They hold close to $700 bil in US treasuries and almost two trillion dollars of US assets altogether. Is it any wonder that this week Chinese officials began to publicly raise questions about the future worth of their US Treasury holdings? During Obama's recent visit to China, leaders there treated him like he was some n'er-do-well in-law showing up the front door with his hand out. I don't think anyone seriously worries that the US might default on its obligations. After all, the US is in the enviable position of being the only country in the world that can borrow as much as it wants in its currency since the dollar is still the main reserve currency in the world. We can always print as many dollars as it takes to pay our obligations. But that's exactly what worries the Chinese and other lenders to the US. Assuming that the Feds at some point will have to open up the printing presses in order to loan money to the US TSY so that it can pay its obligations, a great debasing of the currency will occur. The dollars that we will be sending to our lenders will eventually be worth much less in those lenders' respective currencies.

Such curreny debasing causes inflation. The end of Obama's first term could witness an inflation rate that we haven't seen since the Carter years, thanks to this enormous expansion of the money supply. But maybe inflation is secretly or subliminally what Obama and his econ guys have in mind. After all, inflation is a boon to borrowers and anathema to creditors. Drastically devaluing the currency is a back door, "unofficial" means of defaulting as the borrower is in effect paying the lender back much less than what the lender has bargained for, in the lender's currency.

Notwithstanding this de facto default, the Chinese aren't going to dump their treasuries. The fact is the Chinese need us as much as we need them. The US GDP is almost one fourth of the world's total and US consumers consume almost a third of all the world's goods (ergo, our large trade deficit). The Chinese need the US to keep consuming those goods and will continue to lend to us so that we can continue to do so. The more we consume of their goods, the more dollars they will have and the optimal place to put those dollars is in dollar assets, particularly US treasuries. China can not unload its treasuries without causing harm to its gigantic US treasury holdings. Dumping would also cause US interest rates to soar and hurt their Most Valued Customer.

But that doesn't mean the Chinese will sit idly by while we go on a borrowing binge. They can, if they wish, exert the same leverage and control that any lender has over a heavily indebted borrower. And how might they exert this leverage and control? Don't be surprised if in the near future, some very hush-hush, closed door meetings take place between high government officials of the US and China. Maybe during such a meeting, the Chinese make it clear that they aren't happy with our spendthrift ways. Maybe they strongly suggest that we rethink that big Universal Health Plan that has been put on the table. Or even more likely and insidious, maybe they let it be known that they think our Dept of Defense budget is way too high and needs to be trimmed. Maybe they suggest that we cut back on the F-22 Raptor program or that new state-of-the-art destroyer that's on the drawing boards. After all, as much as the US and China might sometimes seem like two staggering drunks trying to hold each other up, China will increasingly become a military as well as an economic rival to the US. Yes, the Chinese want the US to remain strong economically since we are the primary end market for their manufactured goods; but that doesn't mean that they will not use their economic leverage to keep us from being too strong, particularly from a global strategic power point of view. The US-China relationship has more paradoxes and nuances than a Ingmar Bergman movie.

And what if we have the audacity to say in so many nice diplomatic terms, "Fuck you" to these "suggestions" from our Chinese lender? Then we can expect the Chinese to say, "Okay, then don't expect to see us at your next treasury auction." And since the Chinese have been buying roughly half the bonds at such auctions, that would be a mighty big "Fuck you" back.

Every lender has his borrower by the balls. The last thing a lender wants to do is kill his borrower. But that doesn't mean the lender can't squeeze those balls really hard.

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