China, Trade Deficits and You…
- Apr 14, 2006
- admin
- Entrepreneur, Investing
Here are some thoughts from our readers:
Paul D. has this to say:
“I disagree with your report that deficits are good for the home country. We have not improved our employment picture significantly and we are saddled with a huge debt which has to be paid, and presently there is no effort by our politicians to repay or reduce this burden.
Furthermore, we owe this to a potential enemy. Also, when we lose manufacturing, which we are doing, we lose much valuable research that manufacturers maintain. We must reduce our debt, give the politicians less to spend and improve our exports (Low dollar, at least temporarily).”
I agree Paul, deficits are not good. But remember what this country is good at: creating “client” states. To create a good long term client state we have to initially finance their development. This is done through trade. Once the client “grows up,” they become good, long-term partners of ours. –Dylan
Eric A. had this to say:
Hi Dylan, here’s my viewpoint.
A couple of years ago, while still in the financial service business, I attended a monthly meeting of my local Estate Planning Council. There was an investment trust officer from a local bank and I asked him the following question:
Our budget deficit of about $500 billion dollars equals our military budget. China is ringed with military bases in South Korea, Japan, Philipines, Okinawa, and now since 911, right on China’s border in (I think Kyrgistan) and other former Central Asian Soviet Republics like Uzbekistan, Tadzikistan, etc.
China is in US military crosshairs. And It is financing this. At what point will China say, “you know, we really don’t appreciate your threats, your bombing of our embassy in Yugoslavia, your intrusions on our airspace, your wars based on lies in Iraq (and now war on Iran which would severely disrupt oil China needs) .”
At what point will they pull the plug? That was my question. His answer: “Let’s have a drink”
The financial establishment thinks like that guy above, who actually refuses to even think at all. Manages money for women and orphans and refuses to think about our bullying and profligacy
Dylan, Teeka is saying that China is so addicted to US trade that it will dig its own grave militarily, by financing ours. He thinks so. The financial establishment thinks so. Certainly the military industrial complex thinks so.
I don’t.
Eric, you always provide some of my favorite feedback. But Teeka has a point – if China stopped buying our dollar denominated assets interest rates would rise. That would cool spending tremendously. Nobody is quite ready for that.
The problem comes on the spending side. You always hear that our country has a low “savings rate.” That’s because we spend too much buying things from countries like China.
This is a huge problem because if we don’t save, we won’t have money to invest in our future.
Think of it this way. Let’s say that your family never has money in the bank because you spend like crazy. One day the roof sprouts a leak. You have to borrow money to fix it. And on another day you need to fix your car. Once again, you have to borrow money.
After ten years you’ve borrowed a ton of money and still have little savings. But now your children need to go to school. Of course you cannot afford it.
Since our children are our future where does that leave the country, on aggregate. Not in a good place. (“Children” are an analogy for education, health care, roads, bridges, etc etc). —Dylan
Mack A. also had a few questions that I want to answer one at a time:
“I want to thank Mr. Tiwari for elaborating. But like Stan W. I too have questions regarding exchange rates and do not quite understand the mechanics of exchange rates.
I understand that buying American bonds lowers interest rates – I presume it is because U.S. does not need to raise the interest on its bonds as an incentive for people to buy because China readily buys the bonds. Actually Mack, the lower interest rates from the bond buyers is a good, old fashioned supply and demand issue. Look no further then the recent inverted yield curve: the Fed was trying to raise rates at the short end of the curve but bond buyers kept buying at the long end of the curve.
I understand the implications for the U.S. economy because low interest rates mean lower mortgage payments, and companies are now inclined to borrow for expansion.
What I don’t understand is why China would want to buy our bonds. I understand it is an investment but why choose bonds as apposed to stocks, or anything else. The key to the trade game is your foreign currency reserves. Governments aren’t in the business of stock speculation, they’re in the business of getting the best returns for extremely large pools of money. If they started buying our stocks the market would be at 20,000. But who would they sell them to? U.S equities are far too small a market for a big country to ark its money in.
And how does buying U.S. bonds keep China’s currency low? It doesn’t necessarily keep their currency low. What it does is keep our interest rates low. That keeps our spending high, which means that we’re buying lots of their products.
What does China do to maintain this artificial low currency? The government pretty much says that if you want to buy goods from us you have to pay us a certain amount in relation to every dollar you spend.
Many people believe that their currency is undervalued. In other words, people believe they should be getting less dollars for every product we sell. If you believe that, then China’s desire to maintain an artificially low currency has one main rationale: to get the most dollars for the least yen.
Why would trade restrictions cause China to stop investing in U.S. bonds – presuming that it is in their interest to buy? The trade restrictions being discussed would add a “tax” to Chinese imports. This would slow down our purchasing of their goods. That would give them less money to use to buy our bonds.
I hope that question isn’t too involved. Just trying to get a better understanding of China/U.S. relationship as I want to invest in China/Asia. Ask away Mack, it’s what we’re here for. —Dylan