Since China owns $1 trillion worth of U.S. Treasury bonds and $340 billion of mortgage-backed debt, when China gets a cold, the U.S. catches pneumonia. And -- as I posted -- when we think about the $800 billion bailout bazooka for Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE), we should remember that our money is going to help China out of an investment jam. But since we are at China's mercy, it may be self-help.
This comes to mind in reading the New York Times, which reports that China's central bank, the People's Bank of China, has kept its capital modest as it has gobbled up assets. Now it seeks a bailout from China's finance ministry. According to the Times, "those [$1 trillion worth of U.S.] investments have been declining sharply in value when converted from dollars into the strong yuan, casting a spotlight on the central bank's tiny, [$3.2 billion] capital base [that] has not grown during the buying spree, despite private warnings from the IMF."
This need to replenish capital puts the U.S. economy in the middle of a bureaucratic battle on the other side of globe. The People's Bank wants a stronger yuan while the finance ministry wants a weaker yuan. The Times writes that "as the yuan slips in value, China's exports gain an edge over the goods of other countries." Treasury Secretary Paulson has been on the side of the People's Bank, advocating for a stronger yuan, so his push to bail out Fannie and Freddie can be seen as using U.S. taxpayer money to help it in its battle with China's finance ministry.
What can China do? It could lower its capital requirements for the People's Bank or it could dump its dollar-denominated holdings. Lowering the capital requirements would just make China's central bank less able to withstand a decline in the value of its dollar-denominated holdings. And dumping those assets would cause the dollar to plunge and increase U.S. interest rates.
The lesson for the U.S. should be clear: you can create the illusion of prosperity by borrowing money (U.S. debt has nearly doubled to $10 trillion since 2000), but eventually the bank you borrowed from will get the upper hand. Now we face the consequences of living on borrowed time. Our fate is in Beijing's hands.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter
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Reader Comments (Page 1 of 1)
9-05-2008 @ 11:25AM
william lindblad said...
You have part of it, now look under the rug.
Peter, I am willing to bet that you don't have even a remote idea what I am talking about as you would have to go back into the 1980's, and also be aware of what was going on. Start with the BRITISH Crown colony of Hong Kong and see where the People's Republic had their banking outlet to the West. Try the British bank HSBC and go try to find their origin - like I said TRY. Check out how much of their shop got closed in the U.S. when the mortgage fiasco started.
Check out Armand Hammer and Lenin and you will get the picture.
By the way - the "sneeze and catch cold" line both applies and originated with the U.K. - still true.