June 2,2009
Much as it may want to, the Asian economy cannot tear itself away from the dollar given the level of exposure it has to the US economy today
Much as it may want to, the Asian economy cannot tear itself away from the dollar given the level of exposure it has to the US economy today
I like to relive memories.
Memories of power cuts; the first drops of rain; the smell of wet earth; the red gulmohar in all its glory; Doctor Uncle calling us to receive a trunk call on what was the only phone in the locality; December 25, 1984, when Papa got us our first black and white Uptron TV and we excitedly discovered that Chitrahaar played on Fridays as well; Ameen Sayani host Binaca Geet Mala in his booming voice “bhaiyyon aur behno aaj chauthi payedan pe hai...”; watching Vinod Kambli score a century in an one-day international against England and India losing, with 28 days to go for my tenth standard exams...
I make it a point to visit the city I was born and brought up in every year, just to relive my memories. This year is no different.
“V, we are late,” she said, as I locked the door.
“Don’t worry, we will make it,” I said.
“So you will be away for two weeks. I am going to miss you and our discussions,” she said, as we got into a cab.
“You will? Well, why not start one right now? It’s at least an hour to the airport,” I said.
“Oh, OK,” she said, somewhat startled. “You know, for all your pessimism on the United States and the dollar, the Chinese still haven’t stopped investing in financial securities issued by the US government.
In fact, I was reading somewhere that the Chinese government has bought financial securities worth $34.3 billion in the first three months of 2009. Now if China was so pessimistic on the US, it wouldn’t be buying financial securities issued by the US government in the first place.”
“Hmmm. “If you owe $100 to the bank, it is your problem. But if you owe $1 million to the bank, it is the bank’s problem,” John Maynard Keynes once said.”
“So?”
“China is the bank here and the US the customer. The US government has been spending more than it earns and China has been lending it money by investing in financial securities. As of end-March, 2009, the Chinese had invested a little over $750 billion in financial securities issued by the US government. This year, the US government plans to spend $3.6 trillion, though its expected earnings are at $1.75 trillion. This means they will have to borrow the difference of $1.85 trillion, by issuing financial securities. China has in the past been the biggest buyer of these securities. Now if they were to suddenly stop buying these securities, what do you think will happen?”
“I don’t know.”
“First, the demand for these financial securities will fall. Once demand falls, the US government will have to offer higher rates of interest on these securities to make them attractive for other buyers. This interest rate, in turn, will set the benchmark for the interest rate US banks charge their consumers. And if banks charge a higher rate of interest, people who have taken home loans, personal loans or have credit card dues outstanding would have to pay higher equated monthly instalments (EMIs) to repay these loans. A higher EMI would mean lower savings.
Lower savings would in turn hurt China, as US consumers would have lesser money to spend on Chinese goods, which are exported to the US. The Chinese economy is dependent on US consumers, with nearly 50% of its exports going to the US.”
“Does that mean China is mindlessly buying financial securities issued by the US government?”
“Of course not. In fact, China is buying more of financial securities maturing in a short period of time, usually less than one year. In the first three months of 2009, of the total of $34 billion of financial securities they bought, $15 billion was long term and $19 billion short term. And why are they buying more of short-term securities, if not for the fact that there are doubts over the US government’s ability to repay its debt over a longer term?
With short-term securities, chances of getting back the money invested are much better. In fact, it is largely because of this change in China’s stance that the return on long-term financial securities issued by the US government has gone up to 4.56% from around 3% a year back.”
“I’m listening.”
“In fact in the 12 months from April last year to the end of March this year, China bought around one sixth of the financial securities issued by the US government. Now compare this with the situation two years back, wherein purchases of fresh and existing financial securities by China were more than what the US needed to borrow. To that extent, they are incrementally buying lesser amount of financial securities issued by the US government.”
“Interesting. So things aren’t what they seem like. But I still haven’t understood why the US government plans to spend $3.6 trillion this year when its expected earnings are only $1.75 trillion. The difference of $1.85 trillion is huge, considering the total world savings in a year are around $2 trillion and of course, all of it cannot go into buying financial securities issued by the US government. Even China, despite the Catch-22 like situation it is in, cannot lend such humongous amounts to the US. So where is the money going to come from?” she asked.
“Good question. Let me deviate a little here. See, the US is now saving 4% of its gross domestic product. In dollar terms, these savings amount to around $550 billion a year. Typically, a miniscule portion of these savings go into buying securities issued by the US government. Now let us assume that all of it goes into buying these financial securities. Even that would not be enough given that the US government needs to borrow $1.85 trillion.
So China cannot rescue the US; nor can its own citizens. So what does the government do? It prints the money it is not in a position to borrow. Like that,” I said snapping my fingers.
“I should have guessed. But how long can the US government keep spending twice what it earns? And how does China hope to reduce its dependence on the dollar?”
“Keep that for after I return. We are almost at the airport. As Vikram Seth put it, I can already feel “The peace of loneliness. The scent of imminent rain.””
(The example is hypothetical)
Memories of power cuts; the first drops of rain; the smell of wet earth; the red gulmohar in all its glory; Doctor Uncle calling us to receive a trunk call on what was the only phone in the locality; December 25, 1984, when Papa got us our first black and white Uptron TV and we excitedly discovered that Chitrahaar played on Fridays as well; Ameen Sayani host Binaca Geet Mala in his booming voice “bhaiyyon aur behno aaj chauthi payedan pe hai...”; watching Vinod Kambli score a century in an one-day international against England and India losing, with 28 days to go for my tenth standard exams...
I make it a point to visit the city I was born and brought up in every year, just to relive my memories. This year is no different.
“V, we are late,” she said, as I locked the door.
“Don’t worry, we will make it,” I said.
“So you will be away for two weeks. I am going to miss you and our discussions,” she said, as we got into a cab.
“You will? Well, why not start one right now? It’s at least an hour to the airport,” I said.
“Oh, OK,” she said, somewhat startled. “You know, for all your pessimism on the United States and the dollar, the Chinese still haven’t stopped investing in financial securities issued by the US government.
In fact, I was reading somewhere that the Chinese government has bought financial securities worth $34.3 billion in the first three months of 2009. Now if China was so pessimistic on the US, it wouldn’t be buying financial securities issued by the US government in the first place.”
“Hmmm. “If you owe $100 to the bank, it is your problem. But if you owe $1 million to the bank, it is the bank’s problem,” John Maynard Keynes once said.”
“So?”
“China is the bank here and the US the customer. The US government has been spending more than it earns and China has been lending it money by investing in financial securities. As of end-March, 2009, the Chinese had invested a little over $750 billion in financial securities issued by the US government. This year, the US government plans to spend $3.6 trillion, though its expected earnings are at $1.75 trillion. This means they will have to borrow the difference of $1.85 trillion, by issuing financial securities. China has in the past been the biggest buyer of these securities. Now if they were to suddenly stop buying these securities, what do you think will happen?”
“I don’t know.”
“First, the demand for these financial securities will fall. Once demand falls, the US government will have to offer higher rates of interest on these securities to make them attractive for other buyers. This interest rate, in turn, will set the benchmark for the interest rate US banks charge their consumers. And if banks charge a higher rate of interest, people who have taken home loans, personal loans or have credit card dues outstanding would have to pay higher equated monthly instalments (EMIs) to repay these loans. A higher EMI would mean lower savings.
Lower savings would in turn hurt China, as US consumers would have lesser money to spend on Chinese goods, which are exported to the US. The Chinese economy is dependent on US consumers, with nearly 50% of its exports going to the US.”
“Does that mean China is mindlessly buying financial securities issued by the US government?”
“Of course not. In fact, China is buying more of financial securities maturing in a short period of time, usually less than one year. In the first three months of 2009, of the total of $34 billion of financial securities they bought, $15 billion was long term and $19 billion short term. And why are they buying more of short-term securities, if not for the fact that there are doubts over the US government’s ability to repay its debt over a longer term?
With short-term securities, chances of getting back the money invested are much better. In fact, it is largely because of this change in China’s stance that the return on long-term financial securities issued by the US government has gone up to 4.56% from around 3% a year back.”
“I’m listening.”
“In fact in the 12 months from April last year to the end of March this year, China bought around one sixth of the financial securities issued by the US government. Now compare this with the situation two years back, wherein purchases of fresh and existing financial securities by China were more than what the US needed to borrow. To that extent, they are incrementally buying lesser amount of financial securities issued by the US government.”
“Interesting. So things aren’t what they seem like. But I still haven’t understood why the US government plans to spend $3.6 trillion this year when its expected earnings are only $1.75 trillion. The difference of $1.85 trillion is huge, considering the total world savings in a year are around $2 trillion and of course, all of it cannot go into buying financial securities issued by the US government. Even China, despite the Catch-22 like situation it is in, cannot lend such humongous amounts to the US. So where is the money going to come from?” she asked.
“Good question. Let me deviate a little here. See, the US is now saving 4% of its gross domestic product. In dollar terms, these savings amount to around $550 billion a year. Typically, a miniscule portion of these savings go into buying securities issued by the US government. Now let us assume that all of it goes into buying these financial securities. Even that would not be enough given that the US government needs to borrow $1.85 trillion.
So China cannot rescue the US; nor can its own citizens. So what does the government do? It prints the money it is not in a position to borrow. Like that,” I said snapping my fingers.
“I should have guessed. But how long can the US government keep spending twice what it earns? And how does China hope to reduce its dependence on the dollar?”
“Keep that for after I return. We are almost at the airport. As Vikram Seth put it, I can already feel “The peace of loneliness. The scent of imminent rain.””
(The example is hypothetical)
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