China’s Trillion Dollar Bluff

Is China outsmarting America? Since I began writing this blog, I have paid keen attention to the strange and tempestuous relationship between the world’s greatest industrial behemoth, and history’s greatest debtor. Of course, any student of international relations or history could tell you that diplomacy is a game of bluff and counter-bluff. From Reuters:

China is confident the U.S. economy will get back on the track of healthy growth, China’s Premier Wen Jiabao told visiting U.S. Vice President Joe Biden on Friday during his five-day trust building mission to the United States’ largest creditor.

Earlier in the day, China’s vice president and heir apparent Xi Jinping gave a ringing endorsement of the resilience of the debt-ridden American economy during a second day of talks with his U.S. counterpart.

To which we must ask:

Oh Really?

Oh Really?

In March 2009 The New York Times reported:

BEIJING — The Chinese prime minister, Wen Jiabao, spoke in unusually blunt terms on Friday about the “safety” of China’s $1 trillion investment in American government debt, the world’s largest such holding, and urged the Obama administration to offer assurances that the securities would maintain their value.

Speaking ahead of a meeting of finance ministers and bankers this weekend near London to lay the groundwork for next month’s Group of 20 summit meeting of the nations with the 20 largest economies, Mr. Wen said that he was “worried” about China’s holdings of United States Treasury bonds and other debt, and that China was watching economic developments in the United States closely.

So what made Prime Minister Wen change his tune so swiftly? After all, haven’t Dagong downgraded US Treasuries multiple times? Didn’t S&P just downgrade US Treasuries last week? Hasn’t Ben Bernanke printed shitloads of money in the intervening years?

The answer is that he is bluffing for time. China knows America is sitting on a heap of problems, and is quickly changing its tack away from criticising America, to getting the heck out of dodge. It is becoming clearer and clearer that America cannot and will not produce a coherent economic strategy. China seems to be beginning to offload not only its Treasury balance, but also its dollar pile.  From the FT:

Gold imports into China have soared this year, turning the country, already the largest bullion miner, into a major overseas buyer for the first time in recent memory.

The surge, which comes as Chinese investors look for insurance against rising inflation and currency appreciation, puts Beijing on track to overtake India as the world’s largest consumer of gold and a significant force in global gold prices.

To sum up the mood?

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64 thoughts on “China’s Trillion Dollar Bluff

  1. Oh its okay, i’m fairly confident that the australian situation is much milder then the situation in the Netherlands in 1992 we were sitting on 1701 tons of gold, and today only 612 tons left, 1,100 tons have been sold in the 200-400 dollar range. Set sail for fail !

    And as i stated in a previous post, it defers logic for china to go all in on a sink-USA bandwagon. it is very risky to let the status-Quo unwind in a disorderly manner and China as the culprit. especially since the chinese authorities are suffering from more and more inland pressure regarding the economical stagnation in relation to the high inflation.

    Therfor you see playing “chicken” is picking up world wide at high ranking political/diplomatic levels. And smart-money is moving into PM’s and also diversifying into other commodity assetclasses (wheat/corn/sugar etc.), giving a strong upward pressure in food pricing.

    • I agree with your analysis Marcuz.

      In Britain too we let go of significant quantities of gold for $300 an ounce. I wonder who was on the other end of all of those trades buying gold at 50DJIA:1oz

  2. Incomplete analysis, look beyond that first moment of collapse and where does it leave you. The US ultimately doesnt care, they will keep the game going as long as it benefits them, and then when the SHTF, they will just change the rules. They will happily default on China at that point, or devalue the dollar equivalent to defaulting, and China will get nothing. China needs the US to sell stuff to just as much as the US needs China to buy its debts.

    The US can also at any point in time, cancel all free trade and bring the tariff hammer down on any country they choose. In the end, the US people will get screwed, but US hegemony will go on. In the aftermath, there will be a US renaissance, and re-industrialization (likely with a war to boot). That will create huge growth and capital inflows, and the rich who protected their assets in the crash will jsut get richer.

    Meanwhile China will have all sorts of empty factories, millions upon millions of angry, unemployed and hungry people, and complete collapse. There is no scenario where China comes out ahead in the coming economic collapse.

    Who you need to watch is Russia. They still have all their nukes, a small population, all the resources they could ever need, and are the worlds largest oil producer.

    We will return to a two super power world, as the US collapses like the soviets do, and have less projected influence. China will still be there, but will be fighting to prevent a collapse of their system. They will ally with Russia, Europe and Japan with the US, and beyond that, its just time to pray.

  3. 1/ “China needs the US to sell stuff to just as much as the US needs China to buy its debts.”

    This is the single biggest fallacy in the world today. Look at it from the perspective of the Eurasian autocracies: together they are an autarky, a real autarky. China doesn’t need to sell anything to America: it could very easily convert its consumer-goods facilities to weapons manufacturing, or to improving Chinese civilian/military infrastructure. American economists (especially talking heads like Krugman) claim China is dependent on exporting to America for dollars, but that is like saying that a breastfeeding mother is dependent on her (nuclear-armed) child. The Sino-Russian-Iranian leadership don’t want American anything (except maybe movies and hookers but definitely not liberal democracy), and especially not exporting their resource and manufacturing wealth to america for the ever-depreciating dollar.

    The way China see it, America is shooting itself in the foot more and more. they don’t need to do anything except sit back, diversify their holdings out of dollars, and cook popcorn.

    2/ “In the end, the US people will get screwed, but US hegemony will go on. In the aftermath, there will be a US renaissance, and re-industrialization (likely with a war to boot). That will create huge growth and capital inflows, and the rich who protected their assets in the crash will just get richer.”

    I mostly agree with this, although I certainly don’t think American hegemony exists today, let alone will exist into the future. It’s the “new war to boot” part that I am concerned about. America could reverse its slump now by re-industrialising by fiat, and enacting trade policies to explicitly reduce reliance on China and Arabia. But it seems like the talking heads prefer the idea of a new war, just like they did in the ’30s. Maybe it’s because they believe the world to be overpopulated…

  4. Hi there, have you thought about making a facebook fan page for azizonomics? Most people visit FB daily and it would make it easier to alert them to new posts. This is a bit self-interested – I’ve just discovered your blog (through zerohedge, if you care) and I really enjoy it, but I tend to forget to visit websites I like if I’m not reminded of them.

    Keep up the great work.

  5. Let’s not forget we have two more years of Obama, and I think it’s likely that the final collapse will come on his watch. The guy is a vain, narcisistic, lightweight spokesperson for the true powers behind the throne, international finance and global corporations. We should ask ourselves what it is that these multinationals and power elites want, rather than what the USA wants because the two entities are not necessarily one and the same.
    I should now be able to astound you all with the brilliant answer to my rhetorical question, unfortunately I don’t have a clue what the answer is, but China managing to survive as a cheap manufacturing base, whilst letting the fat, entitlement obsessed and lazy populations of the USA (& Europe) stew in their own juices might be one outcome.

  6. Tropical: Thanks, and thanks for stopping by. Look out for a Facebook page coming soon — probably next week.

    john: What assets are the international financiers and global corporations mostly in? In terms of financial wealth, the undoubtable answer is dollar-denominated UST debt, consumer debt and fiat-denominated cash, equities and derivatives. A very small (and growing) proportion are holding wealth in gold, with the remainder (perhaps 30%) in productive assets, farm land, proven oil reserves. As far as I am concerned, this proves that the financial elite have more to lose with the death of the dollar than the average citizen — who at least has his labour to sell, and his physical possessions to barter. That is the fault of the financial elite for listening to Krugman, for letting Jamie Dimon write legislation (like letting foxes design hen houses), listening to the Dow 36,000 people, and most of all for buying into the UST ponzi, and allowing the U.S. to be deindustrialised all in the name of cheap Arabian oil and cheap Chinese consumer goods. They have destroyed their own empire, like the Roman elites before them with their bread and circuses.

    • I admit that you are probably correct, although attributing the reason for our forthcoming demise to the gross stupidity to our brightest and wealthiest is somewhat depressing.

      • It is very much like a high-tech globalised repeat of the end of the Qing dynasty, the fall of Troy, and the first sack of Rome. I think it will be good for the world, and good for all of us, in the end. Civilisation needs to be shaken from time to time. Otherwise it becomes dull and stagnant.

        Hopefully the next great empires will start colonising and mining space.

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  21. The real problem here, more than anything, is that economists still haven’t fully grasped even the fact that the USA is on the bleeding edge of an actual New Economy. I know that term has been misused a lot, but the USA is the first IP & Services Economy Some others have made some partial transitions in that direction, but the vast majority of the USA’s wealth is in the form of IP & Services.

    The problem here is that the historical mechanisms for valuation of such are egregiously WRONG.

    IP is not real property. Both are “property” in the same sense that ice and steam are water. Attempting to equate the two too far is bound to get you scalded or frostbitten. There’s a massive phase change of behavioral qualities which apply between IP and between RP, not the least of which is near-infinite reproduction at vastly lower price points. All the expense of IP is pretty much completely front-loaded — the expensive one is that FIRST one. All the copies after that are chump change by comparison, costing pennies and less to make and keep. This, plus the inherent impossibility of retaining control over IP means that the amount of wealth actually entering the human social sphere is vastly more than has been realized. For every legitimate copy of Photoshop, there’s a dozen people learning to use it, and/or “foreign nationals” actually using it to do good and significant work. For every legitimate copy of Pearl Jam’s latest, there’s a dozen copies worldwide, providing the exact same social benefit that each and every paid copy provides to its possessor.

    Q.E.D., our systems are fundamentally flawed both because they do not recognize this hidden wealth, but also fail to identify — even for a “first draft” — the rightful recipients of this wealth, i.e., the brilliant creators who turned raw data into information — a unique worldview of raw data that came from that person-creator.

    There are a crapton of Nobel Prizes in Economics to be earned in developing a proper and widespread understanding of How Things Work in a global IP & Services economy.

    • The real problem here, more than anything, is that economists still haven’t fully grasped even the fact that the USA is on the bleeding edge of an actual New Economy. I know that term has been misused a lot, but the USA is the first IP & Services Economy Some others have made some partial transitions in that direction, but the vast majority of the USA’s wealth is in the form of IP & Services.

      As I explained earlier, without energy-independence and supply-chain-independence (i.e. old economy), everything else is extremely (politically, economically and materially) fragile.

      Nonetheless, you raise some fascinating points:

      IP is not real property. Both are “property” in the same sense that ice and steam are water. Attempting to equate the two too far is bound to get you scalded or frostbitten. There’s a massive phase change of behavioral qualities which apply between IP and between RP, not the least of which is near-infinite reproduction at vastly lower price points. All the expense of IP is pretty much completely front-loaded — the expensive one is that FIRST one. All the copies after that are chump change by comparison, costing pennies and less to make and keep. This, plus the inherent impossibility of retaining control over IP means that the amount of wealth actually entering the human social sphere is vastly more than has been realized. For every legitimate copy of Photoshop, there’s a dozen people learning to use it, and/or “foreign nationals” actually using it to do good and significant work. For every legitimate copy of Pearl Jam’s latest, there’s a dozen copies worldwide, providing the exact same social benefit that each and every paid copy provides to its possessor.

      I basically agree with you there. I think there is a modernist disconnect in how academia thinks about intellectual property, and that disconnect is the notion of intellectual property itself. It’s not property. What is really created is intellectual capital. The “property” aspect is largely artificial — you create a patent, and get paid on it. That’s not how society functioned in the past. If you invented a wheel, or a way of grinding wheat, or building with stone, etc someone else could implement it. The secrets behind knowledge (e.g. the construction of Solomon’s Temple in Freemasonry) was jealously guarded. But patent lawyers can’t change reality: once the intellectual capital exists, it’s very difficult to put the genie back into the bottle or make it pay as much as you would want it to. I think the key “innovation” (actually a step backward) is the notion of working theory-to-practice. Reality doesn’t work like that, though the minds of Western academics does. Reality works practice-to-theory: once the technology exists, it flies away with itself.

      This is all another reason why America is fundamentally fragile.

      It’s also something for me to think about as a content creator.

  22. >>> China managing to survive as a cheap manufacturing base, whilst letting the fat, entitlement obsessed and lazy populations of the USA (& Europe) stew in their own juices might be one outcome.

    John, do not confuse the USA with Europe. I concur with the analysis that the majority of Europe is a lot of fat/lazy entitlement-oriented stooges — most of their truly talented people moved to the USA in the last century and a half — but the USA is still far more productive than certain channels hype. Throughout most of the past two decades, the USA’s production has skyrocketed, to the point where, for more than a decade, the USA, with only one sixth of the world’s population, produced a full THIRD of its wealth. The other 7 of the g8 nations produced a third, and the entire rest of humanity — probably 4-5 BILLION people, produced the remaining third — so the USA was probably (I don’t have population numbers handy, so I’m guessing) outproducing the g8 nations three or four to one, and outproducing the rest of the world more than 10:1. You can claim some of that is because we’ve gotten a lot of the world’s resources, but that’s actually a bogus claim. We’ve gotten the resources because we used them vastly more effectively and produced far more from those resources with less effort.

    The USA has certainly overconsumed in terms of real property, but I believe that the prior comment’s gist covers that. We’ve actually produced even more than has been counted and recognized.

    This is relevant since a lot of the new wealth for the next hundred years is going to come from those same IP and Services, and the USA is a master at creating and providing those. The USA’s (and the UKs) IP is sought after the world around. And part of this derives from the USA’s polyglot culture — we are the world writ small. If it has wide appeal — if it sells to US consumers, it will generally sell to everyone else’s too. This is why there is so little competition for the USA in general terms — while other nations produce good IP — India has Bollywood, China has Hong Kong, Japa has Anime, France has its own cinema culture — they are a narrow and limited audience when the whole world is considered. India has a billion people to sell to, but that’s still only 2 in 13. China similarly, though much of what they create does have wider appeal. Japan’s anime has a widespread base of followers, but nowhere near what the USA/UK has for even a single franchise, like Harry Potter, Jason Bourne, or James Bond.

    I’d also cite to you for example, a key statistic the media doesn’t pick up on while hammering their “no manufacturing” meme for the USA. An anecdotal example of it is the following:

    Q: Out of the $600 retail price of an iPod, how much of that winds up in China?

    A: $6.54

    Right — about 1%. The USA gets about $360, other nations get about $187.

    Further, the demise of the manufacturing sector has been vastly overstated.

    Q: Out of all the world’s economies, where did the USA rank in output, in 2009?

    A: #1

    Yes, #1

    Even if you think those numbers are off, they aren’t going to be THAT far off, or someone would easily shred them with statistics.

    The real fact is, the USA’s factories produce more with fewer workers, which is why the decline in jobs, not the fact that the USA is no longer making anything.

    And that’s the proper order of things!!!

    Just as mechanization turned the American Farm Worker from 80% of the population in 1850 or so, to 3-5% of the population NOW, so, too, should roboticization and such reduce the presence of manufacturing jobs in the mix down to 3-5%. Are we lamenting the loss of agricultural jobs? Do we need a jobs bill to raise farm employment? No, we’ve sucked it up and moved on, finding other things for those workers to do. And we’ll do the same thing in the coming years, as manufacturing workers retire and/or become white-collar knowledge workers.

    • Q: Out of the $600 retail price of an iPod, how much of that winds up in China?

      A: $6.54

      Right — about 1%. The USA gets about $360, other nations get about $187.

      With all due respect, most of those calculations by the San Francisco Fed are, at absolute best, inaccurate propaganda. First of all the amount of money that ends up in China doesn’t really matter — what matters in terms of dependency is the nature of the supply chain, and whether that supply chain could function if one part were taken away. If $1 ends up in China out of every 100, but if China could cut off the flow of goods, that would still be fragile dependency. Second, whole lot of “American manufacturing” is just reassembling Chinese components. These two points are explained here:

      http://azizonomics.com/2011/08/25/team-america-world-police/

      Third of all if this uber-optimism were true, and just a tiny proportion of spending were ending up in China, those trade deficits and FX hoards would be considerably less. They’re huge because of American dependency. In many ways Europe is actually better than America: Germany, Eastern Europe and Scandinavia still controls most of their supply chains. They would certainly suffer if Russia cut off the supply of gas, but America would suffer if OPEC and China worked together to cut off the flow of components and oil. America is food-independent, and quite resource-independent, but a lot of that infrastructure would be crippled with a reduction in oil supplies. Every President since Carter has promised to make America more energy independent. Obama looks like first one to have a minor success, but it really is minor. America is consuming less foreign oil (as a percentage of consumption) but if they returned to 2007 consumption levels without new drilling America would have to consume more foreign oil than 2007 (>60%). Now America has a lot of hopes, especially alternative energy. But look at Solyndra: crony capitalism is getting in the way of investment in good technology.

      If America was serious about the technologies I write about here, I would not be so quick to assume American decline:

      http://azizonomics.com/2011/08/17/job-creation-101/

      This is relevant since a lot of the new wealth for the next hundred years is going to come from those same IP and Services, and the USA is a master at creating and providing those. The USA’s (and the UKs) IP is sought after the world around. And part of this derives from the USA’s polyglot culture — we are the world writ small.

      Meh. I don’t dispute America is still a cultural and intellectual hegemon. But that makes me even sadder that America is not energy-independent, and does not control a huge amount of its supply chains — the smartest country on earth is beholden to the interests of tin-pot dictators at OPEC, and gnarled old Confucio-Communists in China. For all of America’s PhDs, all of its “empiricism”, and all of its cultural output, America has by and large failed to grasp the importance of fragility, and the dangers of a free lunch:

      http://azizonomics.com/2011/09/03/the-shape-of-global-parasitism/

      Meanwhile, Confucianism, with all of its ancient dogmas, seems to have grasped fragility rather well.

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  27. Interesting and thought provoking conversation – not heard on ANY news media on TV. I find the last paragraph of azizonomics the more pursuasive position. However, we (the U.S) do miss the benefit of manufacturing that can GAINFULLY employ people like myself, who although intelligent, are (INCREDIBLY), not good at IT or Financial Services; the only truly gainful form of employment second to business ownership. For some reason everyone thinks all intelligent Americans MUST be able to solve complex IT problems. This has left a huge chunk of the forgone “middle-class” without jobs with which they can send their kids to college, or own a decent home. My opinion: This along with energy dependence is the undoing of the U.S., and we can only hope and pray it’s not irreversable.

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