Tuesday, September 29, 2009

The next time somebody asks you, "What if China doesn't buy our debt?"

There's a crescendo of worry regarding the question of whether or not China, one day, will stop buying our debt. Last week, famed hedge fund manager Julian Robertson said the U.S. will experience economic "Armegeddon" if China stops buying. (Proving that you don't have to be smart to make a lot of money as a trader.) And now Paul Volker is in the news alluding the same thing. (Proving that he knows shockingly little about macroeconomics.)

Let's try to break this whole problem down and see if we can understand it piece by piece, shall we?

The first thing you should say to someone who says, "What if China (or anybody) stops buying our debt?" is...

"Okay...can you tell me how China or anybody else pays for our debt?"

If they're halfway on the ball they'll say, "They pay in dollars," or something like that. If you get that answer, that's good enough. (You'll find that some people will even be stumped by your question.)

To be more precise, they pay in reserves. When somebody buys a Treasury, that person's checking account is debited and their bank's reserve account at the Fed is debited in the amount of the purchase.

The reserves balances are lower, but the buyer gets a Treasury.

So far, so good.

But here is the problem with the worry warts' arguments: Reserves are a monopoly of the state, i.e. of the government. Only the government can create reserves!

Therefore, if reserves are a monopoly of the government and buyers of Treasuries can ONLY pay in reserves, then in order for anyone to have the reserves to pay, the government MUST HAVE SPENT THOSE RESERVES INTO EXISTENCE IN THE FIRST PLACE!!

Do you follow me??

When you or the Chinese or the Japanese or your Uncle Frank or ANYONE buys Treasuries, you can only buy them with the government's own money. And the government has a monopoly on the creation of its own money.

How, then, does that equate to a loan from the Chinese??

The answer is, IT DOESN'T!!


How does that happen?

It happens when the governemnt spends. More precisely, it happens when the government defict spends because that is how more reesrves are credited to the banking system. Some of those reserves are held by accounts of foreign banks at the Fed.

When the government spends it increases aggregate demand, which adds to GDP and national income and that gives buying power to American consumers, who then spend on imports and that spending results in an increase in reserve balances for Chinese and other foreign entities' bank accounts.

Then those foreigners simply exchange those reserves (which pay little or no interest) for a savings account of the U.S. government that earns interest, which is called a Treasury. That's all a Treasury is...a savings account of the U.S. government.


Anyway, ask your friend or colleague this: Why in the world would the government need to borrow what it can create without limit???

This whole, "borrowing from the Chinese, thing" is a complete fallacy yet it is going to end up destroying our country.

1 comment:

googleheim said...


This is a good explanation.

It shows that the Chinese are "opening an account" with the US Treasury.

If they are to buy a treasury, they have to use USDollars.

That means they have either have USD already, or they have to exchange their currency into USD.

How about looking closer at :

1. Chinese Recent deficit spending - they spend $600 billion and how did they distribute this ? They credited bank accounts and they did not print any money.

2. ECB - European Central bank - they spend $600 billion and how did they distribute this ?
They credit bank accounts and they did not print any physical money.

3. Reaganomics - how in the world did he manage to deficit spend more than any combined presidential effort in US history without adjustment for inflation ?
He credited bank accounts and they did not print any physical money.

If the Chinese do not invest in the USA golden goose who makes their golden eggs of consumption,
then the Chinese will lose big time.