Ok, so I tried to explain to my friend how our current debt situation is based on short term loans that rollover constantly and adjust to current interest rates. Once interest rates rise to, let's say, 20%, the interest on our national debt will be 3 trillion dollars and we will be officially bankrupt, unless we print the money which will drive our currency to hyper-inflation.
My friend rebuttled saying that basically we will be forced to deny the high interest on the loans and pay back our debts at 0% interest, because those who own our debt would rather take something over nothing. He also tried to make a point that China relies so much on our consumers, that without us they would be nothing. I don't agree with that, but couldn't really lay out any concrete evidence to back up my stance on China without the United States. It seems obvious that they would just sell their products to Chinese consumers while the the United States gets their act together.
Anyway, does he make some valid points? If not, how would you rebuttle his claim?
China only relies on US consumers because of the current government enforced creditor/debtor arrangement. In the old days countries just used to invade each other and take what they wanted. These days we do the same thing though the much more gentlemanly process of 'asking' them, backed up by a massive military and potential policy sanctions, to buy our debt. We in turn use that credit to buy the products they produce. It's a much more peaceful wealth tranfer process than invading and/or enslaving them. The thing is, once they no longer care about and start unloading US currency which is constantly being devalued, that arrangement ceases to be beneficial to them because our currency will no longer hold reserve status and they won't need it to inflate their own bubbles, nor will our currency have the same buying power. But the buying power of the dollar doesn't just evaporate, it gets transferred to other sounder currencies, the holders of which will be more than happy to buy the goods and services previously bought by the US. The key point is that all these transactions depend on the dollar and its value, so the only real question is when will there be enough political will and pressure in China, and other nations to whom the US government owes so much, to say screw the US, call the loans and get what they can, and then start dealing with other nations.
Peter Schiff has written and spoken on this a lot, and his apt analogy is to note that the US is not the locomotive of the world economy, it's the caboose. And if you cut off the caboose, the train can go faster. It's just a question of having the will to make the choice and brave the inevitable but increasingly pathetic attempts of the US to enforce its will upon the world. Other nations have noticed that we haven't won a major war since WWII. Other nations have noticed our debt and know damn well we can't finance many more large scale military adventures. Other nations have noticed that some non US leaders have told the US to go screw itself with increasing degrees of success. Some of them have been murdered, others are still with us though.
Well i think it much more complicated than just this. there is too much politics involved behind close doors to know anything really. I dont think its a far stretch to believe the Chinese have a plan for a US default though.
the Chinese dont need us. They dont need us anymore than anyone needs anyone to trade with. I dont think his rebuttle was any good that we will pay them back at 0%. How does he figure that? Why would the US pay them back over paying US citizens back? I think sometime in the near future, lets just say 50 years, the US wont be able to pay back their loans (personally i think it is much sooner than that). The US citizens own MOST of our debt. So i believe we will pay ourselves back before we pay someone else back, which i dont think we have near enough to pay ourselves back. (I believe in yesterday's mises daily) We have 222 trillion $$$ in unfunded obligations. So anyone who is owed money by the US is screwed. Why does he figure that we will pay back the Chinese over our own citizens?
China does heavily rely on us as consumers, but they would be able to trade with the rest of the world. They are trading with us because we give them the most money for their goods, but it doesnt mean they cant sell to country X for slightly less. Yes their economy will greatly shift and businesses will fail when they are forced to sell products in places that dont give them the same returns. They just wont make as much by selling to anyone else.
The bigger problem i see if the link between fiat currencies. Chinese need the US dollar just like the whole world needs it for stability. When the US defaults on their obligations it stands to reason that US currency will crash too. Which will effect China more than losing us as consumers. I dont know what the chinese know or what their plans are in case of a US default, but when the US dollar crashes the market will be flipped.
"It seems obvious that they would just sell their products to Chinese consumers while the the United States gets their act together." - this is wrong. if they could sell there goods to Chinese consumers they would sell to Chinese consumers. They sell to the US because we give them more money. But yes without the US they will sell to the next most profitable place, and for some goods that might be to Chinese consumers.
this is the Chinese defense against a US default (which i agree) "once they no longer care about and start unloading US currency which is constantly being devalued, that arrangement ceases to be beneficial to them because our currency will no longer hold reserve status and they won't need it to inflate their own bubbles, nor will our currency have the same buying power" and another good point "The key point is that all these transactions depend on the dollar and its value, so the only real question is when will there be enough political will and pressure in China, and other nations to whom the US government owes so much, to say screw the US, call the loans and get what they can, and then start dealing with other nations."
xahrx - "buying power of the dollar doesn't just evaporate, it gets transferred to other sounder currencies" - how do you figure it wont evaporate? someone will get stuck with the US dollar and debt? I think wealth will just evaporate with anyone stuck holding US liabilities. I typically agree with everything Peter Schiff says, is there a link or can you explain how the debt would just "transfer" to other currency? Not questioning a sounder currency wont prevail after a US default, but how would previously held debt transfer?
"buying power of the dollar doesn't just evaporate, it gets transferred to other sounder currencies" - how do you figure it wont evaporate?
Well the buying power of the dollar specifically will just evaporate, meaning eventually dollars themselves will just be worth less and perhaps eventually worthless. However the demand for currency to hold for exchange purposes doesn't just evaporate, nor does the productive capacity of all these nations the US is essentially enslaving to produce stuff for the US consumers to 'buy' with the credit these very nations supplied. So in other words once the dollar tanks what will happen is these other currencies will become more broadly circulated, and prices and production will adjust to serve those people with sounder currencies than the dollar to trade.
So in simple terms when the Chinese can't or won't sell the stuff they make to holders of US dollars, they'll sell to holders of other currencies. The only reason they're selling to the US now is because of the US dollar's special position as the world currency which lets them buy oil easier, and pyramid their own credit on top of dollars, and the US army and the leverage this gives the US in international relations. Once the dollar loses those advantages, and the US military is effectively emasculated, the dollar loses its buying power, but that doesn't mean the Chinese aren't or can't produce things people want anymore. I would guess the industries that got artificially propped up as the result of US monetary policy would get liquidated, at least to the extent their home nations don't also prop them up, and those resources would be re allocated toward producing what holders of other currencies demand.
The important point is that money is an exchange medium, behind it is still supply and demand of actual goods and services. If people can't or won't use one exchange medium, they'll use another. They still want stuff though, and are willing to produce other stuff themselves in exchange for what they want. US policies just skew their production to what the US wants. When the US loses that power, it will revert to what everyone else wants. It's not like no one in China wants a car or a bike, or rubber dog shit even. It just gets shipped to the US right now because we're buying it on credit their governments felt it was in their interest to grant to the US. Once that credit dries up, it's not as if there aren't other people in the world who want this same stuff and are capable of doing something in exchange for it. It sounds like your friend is a typical US blowhard who assumes he's doing the third world savages a favor by allowing them to leave their rice patties and mud huts and make his shirts for him. Trust me, those savages have their own ideas of how they can improve their lives, and endlessly toiling away in some government enforced sweat shop in exchange for increasingly worthless US dollars isn't likely among their most highly prioritized goals.
k thanks. Ya i agree with all of that. I thought you were saying people holding US securities wouldnt lose anything because they would be able to just transfer the debt to another currency.
Great responses guys.
So to make it short and sweet, China does currently rely on United States consumers, since a majority of what they produce is what the United States consumers.. well, consume. But on the other hand, once they refuse to extend us anymore credit and refuse to accept our dollars, they will just divert their resources to make what other's want.
Peter schiff another great analogy: imagine there are three chinamen and an American on a boat that crashes on the shore of an island. They all divy up the labor. Chinaman 1 collects fire wood. Chinaman 2 hunts and fishes. Chinaman 3 builds a shelter. Finally, the American tells the chinamen, "you guys take care of that stuff and I will take care of consuming your products." This is the arrangement the US has with China, and on a micro-level, it is easy to see this is a raw deal for the chinamen. Noting this relationship, ask your friend if the chinamen really need the American.
"If men are not angels, then who shall run the state?"
The best explanation of the fallacy of this view that China "needs" the US consumers.
Another good one.