Tuesday, June 15, 2010

The Buzz: Why China keeps on buying U.S. debt



Here's how the media and most of the economic mainstream perceive foreign buying of U.S. Treasuries...

"China added to its big position in U.S. debt during the month of April, according to the latest figures from the Treasury Department.

So did Japan. And the U.K. And the big bloc of oil exporting nations that includes Venezuela, Iraq, Iran and Saudi Arabia. All told, foreigners increased their net holdings in Treasury bonds and notes by more than $76 billion.

What did you expect them to buy? Euros?"

Check out that last line: "What did you expect them to buy? Euros?"

The author is so confounded by the foreign buying of Treasuries (after all, the U.S. has HUGE debts and is about to receive a credit downgrade any day, at least that's how most of these guys think), that he's practically at a loss to explain the reason for all this buying. In the end he basically throws his hands up in the air and says it's because it's just worse everywhere else.

Pathetic reasoning.

There's one reason and one reason alone that China, Japan, Saudi Arabia and other countries buy Treasuries and that reason is, when the U.S. runs fiscal deficits those deficits add to the savings of the non-governmental sector (domestic and rest of the world) to the penny.

In other words, if the U.S. government rusns a $1.3 trillion deficit, then the non-government (domestic and rest of the world) took in $1.3 trillion in new money. That's how it works as a matter of accounting. Think about it, the government spent $1.3 trillion more than it took in. Where did that money go? Into the pockets of people here in the U.S. and around the world.

Foreigners as well as many Americans keep that money in Treasuries because it earns them a return. Operationaly, the way it works is that the dolars are simply switched from a checking account at the Fed (where they're held) to a savings account at the Fed, which is called, a Treasury. That's it!

So it's not because the U.S. is the best house in the worst neighborhood that the Chinese, Japanese, Saudis, Venezuelans and others buy Treauries, but rather, because fiscal deficits of the U.S. are equal but opposite to the surpluses of the private sector here and in the rest of the world. Government balances and private sector balances must sum to zero.

And they do.

THAT's the explanation.

10 comments:

Hank said...

I love your Blog Mike, I have learned more in 4 months of reading it Vs. 4 years of Economics at UC Irvine. Thanks for the great information!

Brantley said...

"...dollars are simply switched from a checking account at the Fed (where they're held) to a savings account at the Fed, which is called, a Treasury."

Does that mean we now owe interest where as before switching accounts we (US gov) didn't owe interest?

Matt Franko said...

Brantley,
I believe the Chinese exporters who get paid in USD by WalMart, etc effectively get their US bank to transfer the USD to the Chinese Central Banks account at the US Fed. in exchange for yuan from the Chinese CB at the pegged exchange rate (this act may actually help to maintain the peg). These USD become USD reserves to the Chinese CB. at the Fed. The Chinese CB then buys Treasury securities at the auctions with these balances.

Since the Fed pays interest on reserves, I would think that the Chi CB does earn the policy rate (0.25% currently) in the time before the treasry auction.

Mike Norman said...

Brantley,

The payment of interest is self-imposed. It needn't be that way, but it is. It's just like the rule that the Treasury can't run a negative balance at its account at the Fed or, the charade of raising the debt ceiling every year or two. These are all self-imposed. The bad thing is that they give the impression that the government is borrowing from somebody, when in fact that's not really true. The gov't has the power to issue whatever money it needs to pay for the goods and services it requires and provide the means of exchange with which to sustain commerce.

MortgageAngel said...

Then the U.S. must have added to it's "big position" in made-in-China tags, dim-wit!
-In the 80's and 90's Japan was our biggest importer and therefore Japan must have also been the number one holder of U.S. Government Securities (i.e. U.S. debt)
-Panasonic and Sony used to be made in Japan.

Mike Norman said...

Yes, Jill, that's right. Japan was the biggest holder, reflective of its large trade surplus with the U.S. at the time.

Mike Norman said...

Hank,

Thanks for that nice comment. I feel for you. Economics as taught in today's universities is horribly out of paradigm. In my time (late 70s) it was less-so, but already heading in that direction. Now it's just junk: totally taken over by the neo-liberal bias or by mathematical approaches that try to create algorithms for what is essentially a social science. Maybe in the long, long, long term they'll be right, but as Keynes said, "In the long-term we're all dead."

Nicholas65 said...

Hi there.

I did a long follow-up on the Carmen Reinhart presentation from the "Kill Social Security" Commission, and I am informing you here because no one's going to see my comment on your old post.

Please follow link for a complete transcript of her presentation, plus the charts, plus a running commentary from me (totally free, what a bargain).

http://rigorousintuition.ca/board2/viewtopic.php?f=8&t=21495&p=343261#p343261

That's on page 33 of a massive archive of articles about the crash from many perspectives, dating back to 2008.

I shall also quote there your latest post, if I may, because it's a very concise nutshell of modern Keynesian thinking.

It's just so contrary to what everyone's had drummed into them for so long that it also took me years to finally accept its validity, as simple as the concept actually is on its surface.

On the other hand, I don't think it tells the full story. Stimulus alone can't solve underlying economic rot. How it's invested is everything, and we've been making a mess of that for 30 years and far longer.

Much growth is actually illth (the opposite of wealth) - like that oily death spreading in the Gulf.

There are furthermore objective limits to growth placed by nature, and I think we're running up against some of them.

Nevertheless, there is an important truth in the idea that a deficit means more money in all pockets.

(Notwithstanding the price of debt service, but the US hasn't yet figured out to just issue zero percent bonds to itself. I mean, the banksters would think that terrible.)

And yet I expect a dollar meltdown anyway.

Because the markets are self-reflexive, meaning that they are both irrational and conscious of their irrationality (something also central to Keynes's thinking!).

Sooner or later market signals will be taken on the basis of classical deficit theory.

It will be considered that US debt is too high, deficits too high, and the Fed is buying too many treasuries. It will be an irresistible target for attack by the bond market arsonists, independently of fundamentals, just like Europe was.

And I warn you this attack will not be defended against but welcomed by the majority of the US ruling class as the necessary shock required for staging the austerity plans and the clearly-intended assault on "entitlements."

And keep in mind if China's buying today, they're doing it after substantial diversification in recent months. (Last I looked Japan had become the new No. 1 holder of US bonds.)

Unregulated international capital flows are the killer that no one wants to stop.

Matt Franko said...

Riddler/Nicholas,
thanks for the post and analysis, I cant say I agree w you on everything there, but some of it.

Reccomend you stay with Mikes blog here and give it a chance, I think youll see eventually alot of our problems now come out of ignorance by the folks who "govern" us, who dont understand the governments true authorities. There of course is some corruption with those who govern us (that has been with us about forever). I sometimes call them corrupt morons and there are some who are corrupt psychopaths also...I think the internet like this blog will help get rid of some ignorance in our time here and that often gives me some hope.

Resp,

Mike Norman said...

Nicholas65,

Very thoughtful and intelligent comments. Thanks for leaving them and thanks for stopping by. Much appreciated.