Wednesday, November 19, 2008

The powerlessness of credit

Most Americans will remember September 2008 as the month of the Wall Street panic, when Lehman Brothers went under and AIG nearly followed suit. However, we now know that September witnessed one other milestone: the Chinese Communist Party becoming the largest holder of American public debt (Washington Post):
China passed Japan to become the U.S. government's largest foreign creditor in September, the Treasury Department announced yesterday, reflecting the dramatic
expansion of Beijing's economic influence over the American economy . . . China, in fact, may be the government's largest creditor, period. The Treasury does not keep records on domestic bond holders. But analysts said China's holdings are so vast that the existence of a larger stakeholder in the United States now seems unlikely.
So at long last, the CCP has become America's "largest creditor" - and it couldn't have come at a worse time. Don't be fooled by the dramatic rhetoric about the power Beijing has over the American economy (even the Post fell for that). The regime's only true power is in maintaining the fiction of power; any attempt to realize it will fall painfully flat.

To understand why, let's take a look at what would happen if the CCP decided to follow through on the only real "threat" it could make: namely, unload is U.S. Treasury notes.

In the best case scenario, the debt drop drives down the dollar and drives up interest rates. Other international investors do what the Post authors - and everyone else - fear most, they "follow suit" and run away from T-bills. The dollar falls further, and interest rates rise further. Is a default on the horizon? No, that only happens when nations run out of foreign reserves trying to prop up an artificially high currency level. The only such "peg" the American dollar has is set by the cadres themselves (to their own currency) - a peg that they would have to scratch in order to do this. The rapidly declining dollar would greatly exacerbate America's already shaky economic psychology, and the higher interest rates would likely make the oncoming recession much worse.

However, even within these effects are mitigating factors. The higher interest rates will also make American capital more attractive. Whether it would completely negate the currency effect is hard to predict, but it will at the very least reduce said effect, thus eventually slowing down the exodus of foreign investors. Meanwhile, the lower currency would make American exports - long one of the brightest sectors in our economy - even more attractive to international consumers. No one knows better than the CCP what a white-hot export market can do for one's economy.

In the meantime, the dropping dollar will also have another effect - it will cripple Communist China's export sector at a time when the regime desperately needs it to regain its health. Things are far from perfect in Communist China - all attempts to Brezhnevize the situation notwithstanding. Factory closures for this year are already in the tens of thousands. Previous commitments to improve the disastrous ecology have already fallen victim to economic realities (Washington Post). Angry citizens are in open revolt (BBC and Epoch Times). The Korean colony is showing signs of serious trouble (One Free Korea and World Net Daily). This is hardly the time to send the best export market the CCP has into a deeper recession.

Still, one could see the regime doing so if they thought the geopolitical gains against America were worth the serious risk. Trouble is, any geopolitical gains from a weaker America would be countered by the political damage done to the "engagement" crew. Once the American people see the CCP as the cause of their hard(er) times, anti-Communism will enjoy a very fast political renaissance. Just about every tax-cutting Republican and big-spending Democrat can lay the blame for broken promises, lost jobs, and lower incomes at the feet of Zhongnanhai. How many democratic governments would be so willing to do the Communists' bidding (see the Epoch Times for an example) once that happens?

Meanwhile, any reduction of American strength on the world stage would be counteracted by the continuing rise of India, which is (1) right next door to the Communist regime, (2) already more anti-Communist than the United States at present, and (3) very likely to be more assertive on the world stage if, as expected, the BJP returns to power in next year's elections.

So what the CCP would face is a badly damaged economy - and an angrier citizenry - at home, an economically weakened but far more politically aware enemy across the ocean, and a more assertive enemy next door. Again, this is the best case scenario.

In the worst case scenario, all the political effects are still in place, but the rest of the world doesn't follow the CCP in dumping American bonds. This is more likely than it appears. While the American economy is likely headed for a recession, Japan is already there. Meanwhile, Europe is facing its own financial crisis and currency devaluations. The Middle East is drowning in its own oil. Russia is teetering on complete collapse. For more than a few investors, American T-bills are the best thing out there right now - as even the Post acknowledged:

The surge in Chinese buying is part of a rush by panicked investors into U.S. Treasurys, an indication that lending to the U.S. government is still seen as among the safest investments in uncertain times.

"It is occurring in an environment where global investment prospects are less enticing," said Lawrence Goodman, head of emerging market strategy at Bank of America. "There is a movement for foreigners to seek safer haven investments like Treasurys versus more risk-oriented foreign investments."

What happens if the Communists unload their American debt but the rest of the world snaps it up? Then all the leverage and goodwill is gone and the American economy is undamaged (at least by this). Meanwhile, the dollar will still fall relative to the Communist renminbi, meaning the export-market damage would still occur - and even without it, the domestic economy the cadres face is already in bad shape.

In other words, nothing good can come from the actual use of economic "power" that comes with the holdings of American debt. Said power is actually a myth.

Still, the myth itself is powerful, and we can expect the cadres to use is as much as they can, for as long as they can, which means right up to the very moment the democratic world comes to understand all that is written above. At that point, the cadres will come face to face with the powerlessness of credit.

Until then, however, the cadres will use American bonds much like Brezhnev et al used nuclear weapons, as an imposing facade to cover up the internal decay. The democratic world should not be fooled.

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