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Friday, April 06, 2018

Financial nuke or dud?

There are dire warnings about a financial nuclear option in the dawning US-China trade war:
It took China just 11 hours to retaliate against the United States for proposing tariffs on some 1,300 Chinese products, but Chinese officials are holding back on taking aim at their largest American import: government debt.

In a tit-for-tat response to the Trump administration’s plan for 25 percent duties on $50 billion of Chinese imports, China hit back with its own list of similar duties on key American imports including soybeans, planes, cars, beef and chemicals. But officials signaled no interest for now in bringing their vast holdings of U.S. Treasuries to the fight.

China held around $1.17 trillion of Treasuries as of the end of January, making it the largest of America's foreign creditors and the No. 2 overall owner of U.S. government bonds after the Federal Reserve. Any move by China to chop its Treasury portfolio could inflict significant harm on U.S. finances and global investors, driving bond yields higher and making it more costly to finance the federal government.
But a reader explains why the bond threat is toothless.
It’s hilarious reading Drudge headlines about how the Chinese owning US Treasuries is some kind of “nuclear option” for Beijing.

Presumably, China thinks it will somehow crash the value of its Treasury holdings by dumping it on the open market. This is somehow supposed to destroy the value of these bonds…or something. It’s almost as if no one understands how bonds actually work.

Bonds have an intrinsic value, the face value of the bonds which is the amount of money that is returned to bondholders when the bond matures.

This is the par value. If I sell a bond to you for $1,000, then I am obligated to return $1,000 to you plus interest when the bond matures. If I sell a $1,000 bond to you at an interest rate that is lower than the market rate, then I may only collect, say, $950 for the bond, but, at maturity, I am obligated to pay $1,000 back to you plus interest.

If you decide to sell the bond that I sold to you on the open market, then you may get a premium above the $1,000 or you may get a discount below $1,000, but the face value of the bond, the money owed, does not change. Upon maturity, $1,000 is owed to the bond holder.

The value of the bond may oscillate on the secondary market because of the risk of default or because interest rates have changed, but, absent the risk of default, the value of the bond is purely mathematical. Since US Treasuries have virtually zero risk of default, the value of the bond is simply the interest rate paid by the bond, vs. the interest rate of competing securities of similar risk vs. the duration. These can all be calculated in Excel using amortization tables.

There is nothing China can do to devalue US Treasuries by dumping their holdings. If they decide to sell for an artificially low price, then they are simply creating arbitrage opportunities for the buyers and frenzied trading will quickly bid back up the value of those bonds to their mathematically determined price.

See how important bonds and interest rates are in understanding the economy?
The financial trade media is heavily invested in arguing that there can be no winners in a trade war. But they are ignoring the fact that the trade war has been ongoing for decades and the USA has been continually surrendering.

They are also ignoring the uncomfortable fact that if comparative advantage were legitimate, the correct response to tariffs and other trade restrictions would be to do nothing. According to free trade theory, a country is economically better off if it enacts no trade restrictions regardless of what its trade partners do. The fact that various US trade partners are threatening retaliation for US tariffs is further evidence that, despite their free trade rhetoric, they do not genuinely believe in the concept. Nor should they, because it does not work as advertised.

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79 Comments:

Blogger Resident Moron™ April 06, 2018 5:00 AM  

The pertinent point about bonds is not the face value but the implied interest rate. If I can buy a bond that pays $100 interest per annum for $1000 I'm getting 10%. If I can buy it for $500 then I'm getting 20%.

Since in the case of Chinese dumping of US Treasuries, the US govt is the debtor whether I buy new bonds from them or old ones from China. Therefore the risk of default is irrelevant as it applies to both possibilities. It cancels out.

What matters is that the US government borrows tens of billions a month and it has to pay a competitive interest rate to induce lenders to buy its bonds. If I can buy the same bonds from the same borrower for less outlay, receiving a higher rate of return, I'm going to do it.

Dumping $1.7 trillion in US Treasuries would starve the federal government of cashflow overnight, precipitating an enormous crisis and probably world war three. The Chinese won't do it because they know well the nature of the beast they're dealing with, not because it wouldn't be effective.

The reader is simply wrong in this case.

Blogger Wynn Lloyd April 06, 2018 5:02 AM  

The PRC will be a non-factor when it comes to tariffs. They can't continue without the US economy being reasonably strong. Regionalism and unrest would be so great once an economic crash occurred that it would tear China apart. "The empire divided, must unite, the empire united, must divide." Heh.
If anyone knows the circumstances of the business world, it's GE.
Zerohedge and Drudge are not worth reading imho. They are averse to winning. The urge for calamity in them is strong. Some of that is Durden trying to sell the "Sovereign Man" thing.

Blogger Samuel Nock April 06, 2018 5:10 AM  

The last paragraph of this post exposes the sham of free trade.

The only way an economist to respond would be to say the parties are acting "irrationally", which 99.9% of them would not be willing to do without thereby undermining the very world-view they have pushed on us for decades.

Blogger James Dixon April 06, 2018 5:26 AM  

> But they are ignoring the fact that the trade war has been ongoing for decades and the USA has been continually surrendering.

A point Trump has been making consistently in his Tweets.

> The reader is simply wrong in this case.

That depends. How much would the sale of the bonds actually change rates in the long term? Will the rates stay down or will they snap back to what is determined by normal market conditions? The simple fact is we don't know. We know the dumping of the bonds would temporarily push rates up, but we have no idea how long term the effect would be.

If it's a short term blip, then the US should buy the bonds themselves and resell them at a profit.

The US could also simply repudiate the bonds in question, making them worthless. Yes, that would also have an effect on interest rates, but it would make the strategy useless and again, how long term would the effect be?

Blogger Resident Moron™ April 06, 2018 5:42 AM  

We only have one US of A, so it is difficult to make absolute arguments, lacking counter-examples. But for other nations, repudiating your own debts has had multi-decade effects on the willingness of others to lend to them, and thus on the interest rates they're obliged to pay to compensate lenders for that perceived elevated risk.

1.7 trillion is more than the US government's recent annual totals. So it would starve them for more than a year. In the real world, that will never happen; they will go to war long before then.

As for buying them at the cheaper price themselves? Well, with what? They're running a trillion dollar plus deficit; they would have to borrow the money to buy them ... and we're back where we started.

Blogger SemiSpook37 April 06, 2018 5:46 AM  

Honestly, what’s stopping the Treasury from doing a complete swap on that $1.7 trillion and telling the Chinese, “You know, you really need to pay us back on all that debt you’re holding, and no, we do not take artificially deflated yuan. We need something more real.”

Am I barking in the right direction here?

Blogger Resident Moron™ April 06, 2018 6:00 AM  

@SemiSpook

The Treasury is fully converged with respect to globalist disdain for gold, so what would stop them is that it would be contrary to everything they believe about the purpose of their existence in the modern global economy.

They WANT your job to be taken by a Chinese peasant paid a dollar a day. They think that's a benefit to the "global economy" and they don't care at all that it is devastating to YOUR personal economy.

Blogger Aeoli April 06, 2018 6:12 AM  

I learned a ton from this. Voxiversity fodder?

Blogger Nathan April 06, 2018 6:24 AM  

I've always thought this was the real nuclear option. The US has the consumer base to recover from repudiating some of the debt, without the debt, China has nothing. And if there was some pretext to legitimize repudiating the debt, like a war, well, then why wouldn't interest rates recover.

Blogger James Dixon April 06, 2018 6:27 AM  

> But for other nations, repudiating your own debts has had multi-decade effects on the willingness of others to lend to them, and thus on the interest rates

Agreed. But we're in uncharted territory here. How often have hostile nations tried dumping bonds? My knowledge of economic warfare history is essentially non-existent.

> 1.7 trillion is more than the US government's recent annual totals. So it would starve them for more than a year.

Up to now, the demand for US credit has essentially been insatiable. We simply don't know what the limits are.

> As for buying them at the cheaper price themselves? Well, with what?

With other debt. We just have to find a buyer. Or, the government could take the right to print money back in house and simply print the money to pay off the bonds. That would probably destroy the Federal Reserve and bump up inflation, but...

As I said, we're in uncharted territory. But the US does have actions it can take short of war.

> Honestly, what’s stopping the Treasury from doing a complete swap on that $1.7 trillion

Nothing except that they have to find a buyer.

> “You know, you really need to pay us back on all that debt you’re holding, and no, we do not take artificially deflated yuan. We need something more real.”

They don't owe the money to us. We owe it to them.

> The Treasury is fully converged with respect to globalist disdain for gold, so what would stop them is that it would be contrary to everything they believe about the purpose of their existence in the modern global economy.

That's been true in the past. But we have a new sheriff in town, and he seems to care somewhat more about the personal economy of those he supposedly represents.

Blogger Looking Glass April 06, 2018 6:39 AM  

@1 Resident Moron™

Fed would just buy them up instantly. Welcome to the Fiat Currency world. China has no ammunition in this Trade War. That's *exactly* why the Media are going nuts.

Trump won this the instant he moved his plan into action. USA has all of the leverage in all of these situations, but Trump is still acting appropriately. They can use whatever public rhetoric they want, but Trump hasn't run anyone out of the market. That comes Next. If they're stupid, they'll find out how nasty Next can be.

Japan and a few other saw this coming from a mile away and made a deal before April 2017.

Blogger Fred April 06, 2018 6:42 AM  

Cutoff soy bean exports to China 100%. Lets experiment and see if Chinas leaders can stay in power without our soybeans. The odds are much against that.

Blogger VD April 06, 2018 6:43 AM  

As for buying them at the cheaper price themselves? Well, with what? They're running a trillion dollar plus deficit; they would have to borrow the money to buy them ... and we're back where we started.

The Fed would buy it all. This isn't rocket science.

Blogger Looking Glass April 06, 2018 6:46 AM  

Also, while they wouldn't do it, the Fed and associated Major Banks could collapse the Yuan in a couple of days. It's just a matter of setting the Algos to "Kill". You can see what they did to the Ruble in 2014, if you want to see what it looks like.

Halving the value of the Yuan would start a cascade financial event that would end with the collapse of the Chinese Regime. It's why the "trade war" might just be completely pre-planned bluster, as Trump offers Normalization while holding the Death card in reserve. Talk about leverage.

Blogger Stilicho April 06, 2018 6:48 AM  

The Fed could buy the bonds and coerce the tbtf banks to do the same. Fed buying dilutes the value of the dollar some, but there's plenty of room there with the dollar being relatively strong despite some recent declines. A five percent decline in the dollar is absorbable. As is a ten percent decline from current levels. It also makes US exports more attractive to other countries which could have positive effects on manufacturing in the US. Savers would take a hit, but when has the Fed or fedgov ever cared what happens to savers?

China can't win a trade war with US and chicoms know it.

Blogger Looking Glass April 06, 2018 6:55 AM  

It's also important to know while the USA does export a lot to China, it's mostly fairly specific things. Quite a few of the big ones are things that are barely used in the USA proper. Rising the price of dark meat Chicken & pork is going to cause a whole lot of grief for the ChiComs.

Blogger Resident Moron™ April 06, 2018 7:02 AM  

The idea that the Fed is independent of the US government is a polite fiction that requires a certain degree of restraint to be maintained.

Yes, the Fed could theoretically buy 1.7 trillion in US Treasuries overnight.

But no action is without consequence. The Fed's monstrous inflation of its balance sheet during the bailouts of circa 2008 had corresponding consequences.

That enormously momentous event would be as a drop in the ocean compared to what you're talking about. I'm not saying you're wrong, at all. What I'm saying is that we've all known for a long time that the Fed will merrily destroy the global economy trying to save it.

You know, like that village in 'Nam ...

OpenID markstoval April 06, 2018 7:03 AM  

@15

"China can't win a trade war with US and chicoms know it."

Neither side can "win" a full blown trade war, but this is not going to be one. This is Trump negotiations. The man plays hard.

The USA is China's biggest customer. They want things to stay as they are as much as possible. We NEED things to change. I think Trump intends to see things change.

Good on him.

Blogger Resident Moron™ April 06, 2018 7:06 AM  

@Looking Glass:

The biggest or second biggest economy has no ammunition in a trade war?

Come on ... I can be wrong, but that's nonsense.

Blogger John Doe03526 April 06, 2018 7:09 AM  

The organs of state propaganda still don't get Trump. This is all a negotiation. At the end of it we'll have a better trade relationship with China.

Blogger Nate April 06, 2018 7:33 AM  

The soy bean tariff is a total desperation move

Blogger Johnny April 06, 2018 7:56 AM  

I wonder how much you can even target a trading partner for a generic product like soybeans. Do they buy from somebody else, and do we then sell to the somebody else they buy from?

Soybeans work out well in a corn rotation and because we grow so bloody much corn, soy is a natural crop for us. I doubt there is some other country that would expand as a major supplier.

As for the effect on the agriculture sector, on a transitory basis it would damage crop farmers and help the livestock growers owing to lower prices internally. Not helpful but not devastating either.

Blogger Mr.MantraMan April 06, 2018 8:19 AM  

I'll start the bidding for the Chinese portfolio at 1 fiat dollar.

Blogger James Dixon April 06, 2018 8:26 AM  

> The biggest or second biggest economy has no ammunition in a trade war?

The have plenty of ammunition, but none of it is enough. They need to sell to us far more than we need to sell to them. If we cut all trade with them tomorrow and they sold all our debt we'd feel it, but it would devastate them.

> This is all a negotiation.

Exactly.

> I wonder how much you can even target a trading partner for a generic product like soybeans.

As I noted on Gab, the word is fungible. Short answer, you can't.

Blogger Looking Glass April 06, 2018 8:36 AM  

@22 Johnny

Interior prices, sadly, would barely budge. That's the "power" of controlled markets.


@19 Resident Moron™

The USA needs almost nothing from China, China's currency is over-valued (intentionally), and trying to sell 1+ Trillion in Treasuries doesn't happen on the open market. So, China has no leverage on Trade. At all. That's why the Media is going nuts.

The Globalists setup the US Financial Markets as a global hegemony, that's why China bought the Clintons & so much influence. It's why all of the foreigners buy so much influence. Most of them are utterly dependent upon access to foreign markets. China is probably the most.

The reason for the story in Inception is that Saitou's company could never compete, so he hired Cobb & crew to implant an idea to break up a company. The USA is the competitor that has to be broken up because no one else can compete. But, suddenly, somewhere deep in the dream, Trump rolled up in his limo and said, "get in this car, we're Making America Great Again".

Utterly Random Side-point: this isn't the first time that a Nolan brothers movie has extremely well understood the dark side of the Globalist project. Jonathan Nolan is extremely good friends with Elon Musk. This probably requires deeper inquiry.

Blogger Looking Glass April 06, 2018 8:49 AM  

China should have the 2nd largest economy, but it's more than likely closer to 12 Trillion USD equivalent. The financial games make it look far stronger than it is.

China is a net calorie, energy and water (yes, fresh water) importer. It means they've peaked. Their financial markets actually started crashing right on time, but they basically prevented anyone from selling to prevent a complete collapse a few years ago. Working-Age population already peaked and actual population decline starts soon.

All of the massive amount of raw material imports they need for their export economy to work are denominated in USD. Any radical lowering in the relative value of the Yuan crushes huge chunks of their manufacturing base because of rapidly rising costs, then respondent tariffs from other countries to prevent them dumping or flood their markets far below the costs anyone can actually produce.

China has guns but no ammo in this fight, which is exactly why I think this is a pre-decided bit of kayfabe. Trump has told China that the USA would be normalizing, it was up to them how this played out. That's why China isn't responding much, though lots & lots of optics stuff.

Always remember: One ping only.

Blogger Avalanche April 06, 2018 8:58 AM  

@1 If I can buy a bond that pays $100 interest per annum for $1000 I'm getting 10%. If I can buy it for $500 then I'm getting 20%.

Ooh hey cool. I would buy some of those "20% bonds" -- who else has some liquid cash for the fire sale?!

In manufacturing, we call that 'reshoring' -- bringing the MFG back into the U.S. cause the current location isn't working out.

Blogger Tino April 06, 2018 9:03 AM  

U.S. Treasury bonds can and will default as Treasury has no solvency, Federal Reserve magic notwithstanding, which will not work in this case as there is no asset to back the paper. Also, Y'all are not privy to the level of paper written by the Fed Reserve, which is in the multi-quad range. So yes, the nuclear option exists but China isn't going to use it over this tariff squabble. A Treasury Reserve Note is in the offing, which in time will replace the already dead-but-doesn't-know-it FRN.

Blogger Resident Moron™ April 06, 2018 9:05 AM  

@Looking Glass

For slightly different reasons, I tend to agree with your conclusions. China isn't looking to start WW3 fighting against their biggest customer, the one country that pays their peasants just enough to keep them from slaughtering the whole communist party membership.

Basic economic principles don't go away tho: every benefit has a cost and nobody is immune. The same financial games that make China look bigger than it is also make the USA look bigger than it is.

Blogger horsewithnonick April 06, 2018 9:05 AM  

Mutually Assured Destruction - it isn't just for nukes anymore!

Blogger James Dixon April 06, 2018 9:16 AM  

> Basic economic principles don't go away tho: every benefit has a cost and nobody is immune.

Absolutely. The cynical part of me wonders if Trump isn't doing this deliberately. Trump has been through bankruptcy. He knows first hand both the power and danger of debt. He knows our current path is not sustainable. If China crashes the bond market, it means dealing with our debt now, when we can still (it would mean a roughly 30% reduction in federal spending to balance the budget and then 30 years to pay off the debt). Not 10-30 years when it will be much worse and could break the country.

In his mind (and mine) that might be a good thing.

Blogger Andrew April 06, 2018 9:20 AM  

I'm with Resident Moron on this. The issue isn't so much the stock of Treasury bonds already outstanding (the $1.7 trillion held by china for instance) but the net outflow of dollars every month required by the US government to keep things going. We send, net, $50-60 billion of new dollars out into the world every month (entirely due to fed gov spending since our annual fiscal deficit is larger than our annual trade deficit) and all that has to absorbed by someone, typically via US debt, for the system to maintain function.

Blogger 罗臻 April 06, 2018 9:30 AM  

The Chinese media isn't stupid. Although the official propaganda says China will win a trade war, a famous financial reporter pointed out China's economy will be in shambles with possibly 10x the job loss if it fights a total trade war with the U.S.

Chinese Media: China Loses All Out Trade War

I'm also not entirely sure this is only a trade war. Luttwak proposed slowing China's economy was a way to slow its military modernization. If their GDP growth slows, it could delay their catching up with the U.S. for decades, if not "forever." If that is U.S. strategy, but China thinks this is only about Trump winning some trade concessions, they've already walked themselves into the trap. Even if this wasn't the plan, what do you think NSA and Defense might be telling Trump as this confrontation evolves? Logic says someone is seeing a great chance to set China back for a decade or two.

China Walks Into Trade Trap

Blogger SDaly April 06, 2018 9:32 AM  

What is China going to do with $1.17 trillion (or less if they have to sell at a discount)?

Blogger Andrew April 06, 2018 9:36 AM  

Btw, there is great value to fiat currencies in fostering and growing international trade as the last century shows. And there is great value to the international trading system having a common reserve in which to settle that trade. That's why the US is still able to print endlessly without consequences. But the system is not sustainable forever, the debt grows endlessly and eventually the system will break. Perhaps if the paradigm shifted to one where international trade was settled, not in a reserve currency, but a reserve asset, separate from any currency, that everyone values and that could float in price as needed. Physical gold bullion perhaps.

Blogger 罗臻 April 06, 2018 9:37 AM  

This comment has been removed by the author.

Blogger Looking Glass April 06, 2018 9:37 AM  

@29 Resident Moron™

If we got an actual normalization event within the financial markets, the USD would skyrocket. This is the reason why every attempt at figuring out standard of living keeps putting Mississippi over nearly all of Europe. The wealth difference is absolutely massive and it has a lot to do with things that aren't easily measured.

However, is the USD did normalize, most of the world would only be able to afford to buy Food & Energy from the States, as that'd eat up their entire networth to accomplish. They can't compete, which is exactly why the various post-WW2 systems were setup the way they were.

If China got too annoying, the Fed would just push the price of Oil up past $100 per barrel again. Considering where the Ruble still is, Russia wouldn't benefit too much from the increase, yet it would drastically suppress China right now. (They've notably been less interested in jacking up cereal grain prices since the food riots the last time Corn prices spiked.)

Blogger 罗臻 April 06, 2018 9:38 AM  

Dumping treasuries doesn't work even if you allow that it pushes up US interest rates because the fallout is all negative. If it causes the U.S. dollar to drop 20-30%, then the USA wins the trade war against the world and doesn't need tariffs. It has competitively devalued and exits depression. China suffers a deflationary depression. If it causes interest rates to rise and the dollar then rises as money flows into treasuries and risk assets are sold for cash (dollars), then the world gets global deflation and the Chinese economy collapses.

China's one ace is they can devalue the yuan. It's easy for them to do. They could announce that as part of the deal with the USA, China will open its capital account and stop intervening in the currency market. The yuan will drop 20-30% because they have a massive credit bubble. They tightened their capital controls in 2016 and 2017 to prevent their dollar reserves from draining and protect the yuan exchange rate. Also, if there is a major trade war, the yuan will devalue anyway. Thus, if there's a large enough tariff threat, their best and only option is allowing their currency to fall. I expected it would fall first because of their credit bubble and then trigger a trade war, but it looks like it will happen in reverse.

The Logic of Strategy: Yuan Devaluation and the Road to Trade War

Blogger Mr.MantraMan April 06, 2018 9:40 AM  

Won't China going outright hostile expose its agents (mainly jewish and caucasian) in the USA to legal action?

Think of poor Tim Donahue or Mitch and Paul.

Blogger 罗臻 April 06, 2018 9:40 AM  

What is China going to do with $1.17 trillion (or less if they have to sell at a discount)?

They need the dollars to back the exchange value of the yuan. Those treasuries are why 6.3 yuan buys $1. As it is, that will probably fall to around 8 or so because of their inflation since 2008. They would have to hold the dollars they got from selling yuan, or buy foreign currencies such as euro and yen, which would cause their currencies to soar versus the dollar.

Blogger NO GOOGLES April 06, 2018 9:41 AM  

I don't wholly agree with the analysis in the OP. It's about 90% correct.

The analysis forgets to mention one very important factor: inflation. Inflation changes the "real" value of the bond at maturity. If China dumps $1tn of US bonds it's very likely they won't have a problem selling them. However, if there is less demand for Treasuries as a result of China's bond exit, then bonds will increase in value (IE, the government will have to offer more interest to attract buyers).

More interest = more government spending = more deficits and likely that means more government debt. Basically if China does sell off their Treasuries it will likely have the longterm effect of devaluing future Treasuries due to increasing future inflation.

Of course, this effect is mitigated by the fact that a lot of the market for US debt is in the form of TIPS. That doesn't totally get rid of the problem though, because even the inflation indexed bonds are only indexed to CPI which doesn't account for a lot of actual monetary inflation.

Overall though, China dumping its Treasuries wouldn't be a big deal. Maybe it make a noticeable difference 10+ years down the road, though.

Blogger Looking Glass April 06, 2018 9:47 AM  

@36 罗臻

The one thing is that we don't know the Behind the Scenes deals. Trump doesn't up the Rhetoric until he has the game board completely controlled. The unfortunate reality is the USA is more than willing to ruin the economies of other countries, though my read is that Trump has no desire to get involved in going that far. This leads me to assume that he's worked out a deal with Xi, since he holds all of the leverage. Everything from here on out is about saving face.

I would expect them to move back close to 7. Beyond that and things start exploding in chunks of China's economy. Taken together with the tariffs, a lot of staple prices are going to rise in China and the leadership will seek to make that a slow process.

Blogger Arthur Isaac April 06, 2018 9:50 AM  

Can China eat dirt? Just curious how rare earth metals go down.

Blogger Looking Glass April 06, 2018 9:53 AM  

@43 Arthur Isaac

I hear it's absolutely electric.

Blogger 罗臻 April 06, 2018 9:58 AM  

@42

The calculation would be made by the folks in national security and defense who believe a war with China is coming or who want to keep China from taking over the South China Sea in the next decade (along with Australia, Japan, Vietnam, Indonesia, Thailand, Malaysia...) Luttwak didn't propose to collapse China's economy, only slow it by 2-3% of GDP with restrictive trade policies. Then it's mathematically impossible for them to catch the USA and they don't have enough surplus to rapidly expand the military.

Blogger Looking Glass April 06, 2018 10:03 AM  

@45 罗臻

The point makes sense, though I don't think the Chinese economy is robust enough to absorb that type of shock, even if it should seem small.

Blogger Ominous Cowherd April 06, 2018 10:10 AM  

Arthur Isaac wrote:Can China eat dirt? Just curious how rare earth metals go down.

If you like rare steak ...

Alaska has at least one rare earth mine which could swing into production once permits are in place.

Blogger Daniel Bendele April 06, 2018 10:26 AM  

Quick question for those more in the know: Aren't we (along with most of the world) VERY dependent on the Chinese for rare earth elements? Especially those in their final usable state? Wouldn't that be a more viable "nuclear option" for the Chinese to use in a theoretical "Trade War"? I feel like I remember a big spat between the Chinese and Japan or Korea where they basically cut off the supply of those types of minerals and it was a big deal with the WTO.

Blogger Looking Glass April 06, 2018 10:41 AM  

@48 Daniel Bendele

Mining is always about cost. You'd be surprised how quickly certain things can come online when the price is right.

Blogger 罗臻 April 06, 2018 10:50 AM  

Aren't we (along with most of the world) VERY dependent on the Chinese for rare earth elements?

Yes in the sense that we need them and China supplies most of them today. No in the sense that they're not actually rare on the planet.

Blogger Stilicho April 06, 2018 10:59 AM  

@18 mark stoval: yes, the US can win a trade war with China. End all trade with China and our GDP increases as do domestic wages. Financial sector takes a hit as do offshoring corporations. That's what we call a win/win.

Blogger The Anti-Gnostic April 06, 2018 11:46 AM  

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Blogger The Anti-Gnostic April 06, 2018 11:47 AM  

I'm with Resident Moron on this. The issue isn't so much the stock of Treasury bonds already outstanding (the $1.7 trillion held by china for instance) but the net outflow of dollars every month required by the US government to keep things going. We send, net, $50-60 billion of new dollars out into the world every month (entirely due to fed gov spending since our annual fiscal deficit is larger than our annual trade deficit) and all that has to absorbed by someone, typically via US debt, for the system to maintain function.

As the process was explained to me, the TBTF banks ("primary dealers") are obligated to step up to the plate and buy a certain amount of new issues. After that, there are always buyers for Treasuries--they are practically as liquid as cash. If there still aren't enough buyers at the rate the Fed wants to target, then the Fed steps in and buys the rest. The extent to which the Fed uses its cash on hand or simply credits the amount in the Treasury's account is unknown--hence the Pauls' perennial call to "audit the Fed." I'm confident the Fed doesn't have a weekly stash of billions in "real" cash lying around, so I conclude it doesn't really matter at this point. It didn't matter in 2008, when the Fed bought mortgages and student loans instead of Treasuries.

I've been told all my life that you can't print money and buy your own debt with it. My father reminds me he's been told the same thing all his life. What is money at this point? Why do we even bother with taxes?

If the Austrian economists are right we're headed for the Mother Of All Busts but again, we've been told that for a long time.

The alternative implies that we've practically abolished Scarcity: there's enough productivity in the economy that it no longer really matters how much money we print up. Japan measures its debt in the quadrillions.

It's all above my paygrade at this point.

Blogger Demonic Professor El April 06, 2018 11:52 AM  

If I remember correctly, about 1/3 of China's economy depends on the US. If they dump the bonds, which wouldn't be really effective anyway, China's economy sinks. And they know it.

The MSM freaks out because it's Trump and they oppose anything Trump. Financial thieves oppose it because their portfolios drop a few cents temporarily (and their global scams start to dry up). Idiot leftists think their iPhones will cost an extra $300 because they're financial and mathematical illiterates.

The worst that would happen in the US is a slight increase in prices until domestic production of stuff like steel goes up. In the case of steel and other metals, mining operations would come back or increase. Overall, a "trade war" with China is good for the US in both short and long runs.

The worst that would happen is some EU and Latin American wussies stomp their feet and cry foul. If China dumps all the bonds, worst case - as has been said here - the ChiComs are out because their inflation/export charade is up.

@51 Stilicho

As you said sir, this is a win/win.

Blogger Demonic Professor El April 06, 2018 11:56 AM  

Plus, look at this - interest rates are about to increase and none of the financial MSM are saying to buy bonds, which means that GE Trump is going to start selling bonds soon. In addition to that, GE Trump is throwing down a large amount of money on infrastructure spending and repair.

A good time for us peasants to invest in bills, notes, and bonds.

The GE knows what he's doing, bless him.

Blogger James Dixon April 06, 2018 12:05 PM  

> If the Austrian economists are right we're headed for the Mother Of All Busts but again

They are, but timing is everything. No one knows when exactly the bust will come or what will trigger it. But the world wide level of debt we have no cannot be sustained.

> A good time for us peasants to invest in bills, notes, and bonds.

The value of existing bonds falls as interest rates rise. Unless you plan to buy individual bonds and hold them to maturity, it's not a really good time. You might consider preferred stocks though.

Blogger SouthRon April 06, 2018 12:10 PM  

Sounds like a hollow threat to me. While $1.7 trillion isn't even equal to the daily trade in commodities 20 years ago, I don't think even the Chinese could unload that overnight without taking a huge hit on the price getting out of them.

We're going to punish you by losing money! That'll teach ya!

Blogger Demonic Professor El April 06, 2018 12:15 PM  

@ 56 James Dixon

For expediency, preferred stocks over bonds for sure.

And you're right - it's more of a "keep an eye out" kind of thing on bonds rather than rush to buy. Interest rate:value are pretty sucky right now and probably will be for a while.

Hmmm. Upon further thinking, GE and the like are too smart to push for bonds right away while finance is still in the hands of the globalistas. Private investment like steel and manufacturing equipment (stuff like that) would be better. Thanks!

Blogger Dave April 06, 2018 12:18 PM  

China will play the long game as Vox said on the Dialogue show. They know Trump will eventually be out of power, and having already bought everyone in the establishment they needed, it's just a matter of waiting him out. Now is mostly about posturing and saving face.

Blogger Ingot9455 April 06, 2018 12:20 PM  

We actually have an example of what would happen if China dumped all our bonds and quit buying, from the Obama years.

Let's say suddenly there's so many Treasury bonds out there and at a price low enough we can't sell. But we have to sell 50-60 billion a month. That's actually fairly close to the level of quantitative easing that we we doing to keep afloat during the Obama times.

So we'd see 'real inflation' very similar to the Obama years. Real stuff like food goes up in price and the manufacturers play games like taking a 12 oz can and making it 11 oz and rejiggering the prices. The government will desperately cling to its no-food-nor-fuel inflation measure. Automobile prices will rise at something like the actual inflationary measure - my 2005 car cost $16,000 new but to get essentially the same car in 2016 with the Obama years in there it would be $25,000. And the press would try to make as much hay out of it as possible.

But it would only last 6 months to a year, and our current energy policy and tax policy and various other pro-growth get out of the way Trump policies would blunt that even more.

No big worry.

Blogger RobertT April 06, 2018 12:24 PM  

If the ability to repay the bonds comes into question, the market value could very well diminish. Those are the bonds that financed the new world order. This is government debt. We did not buy tangible value with that money, no washing machines or cars; we bought votes with it. We bought good feelings. Like a drunk buys vodka or four roses or bali hi. The votes have long since been cast in elections few can even remember the issues, but the bonds remain. The only solution for every country in the world is default. What China bought with the money will turn out to be as worthless as the already cast votes. What idiot thought that would work out well?

Blogger Andrew April 06, 2018 12:29 PM  

The Anti-Gnostic,

When the fed gov spends it is spending credit money into the system (via sale of Treasuries). Money that circulates globally for as long as the dollar is a viable currency, or until it finds its way back into Treasuries and is eventually retired or until it goes poof in a credit contraction. When the Federal Reserve buys Treasuries, it is creating base money to remove debt that has already been spent into the economy from the balance sheets of the TBTF banks. These are two different things. The Federal Reserve is not spending money into the economy like the fed gov does, but basically swapping out Treasuries for base money at the reserve level in the banking system.

Blogger Snidely Whiplash April 06, 2018 12:55 PM  

The real threat is a bond market dislocation, where it becomes impossible for the US Treasury to sell bonds, either because of trust issues, or because the market-determined interest rate is too high for the US government to actually be able to pay. We are several decades into a pattern of selling bonds to pay the interest on the bonds sold previously. An historically-appropriate rate would be in the range or 3-5%. refinancing 0.01% interest bonds at 4% would literally consume the entire federal budget.
But this move would not without cost for China. virtually their entire financial system is leveraged off of Treasury bonds. Reducing the value of the bond portfolio by even 10% would seriously endanger essentially every Chinese bank. The leverage would go from hundreds of times the value of the bonds to thousands of times. Margins would disappear.

China would likely survive, but the people in charge in China would have their portfolios wiped out.that's why they won't let it happen.

Blogger LateIntoTheFray April 06, 2018 1:10 PM  

Had dinner with an industry rep on Wednesday that said China was specifically targeting Republican districts up for re-election with their tariffs on. Haven't seen much if anything in national news on this, I'm shocked! I thought the media was outraged when foreign governments would try and interfere in US elections????

Blogger James Dixon April 06, 2018 1:19 PM  

> The real threat is a bond market dislocation, where it becomes impossible for the US Treasury to sell bonds, either because of trust issues, or because the market-determined interest rate is too high for the US government to actually be able to pay.

Yes. But we're apparently still a ways from that happening. It will happen eventually. It always does.

> Had dinner with an industry rep on Wednesday that said China was specifically targeting Republican districts up for re-election with their tariffs on.

That appears to be their tactic, yes. It won't work.

> I thought the media was outraged when foreign governments would try and interfere in US elections????

Not if it helps their side win.

Blogger Pale Male April 06, 2018 1:26 PM  

Looking Glass wrote:China is a net calorie, energy and water (yes, fresh water) importer. It means they've peaked. Their financial markets actually started crashing right on time, but they basically prevented anyone from selling to prevent a complete collapse a few years ago. Working-Age population already peaked and actual population decline starts soon.
So Xi Jinping gets to be president-for-life over the imminent collapse of the Communist dynasty?

Time to make popcorn.
Avalanche wrote:In manufacturing, we call that 'reshoring' -- bringing the MFG back into the U.S. cause the current location isn't working out.
Um, yeah, about that.  The trend seems to be that automation is making the job possible with far less labor (though higher human capital), so even when the mfg comes back most of the jobs don't.  Ask the former workers of Generac about that.

50% of all jobs are projected to disappear through automation by 2030 or so.

James Dixon wrote:How often have hostile nations tried dumping bonds?
I've read that the Suez crisis was ended in Egypt's favor when the US threatened to dump its UK bond holdings.

I wouldn't be surprised if this is where Soros got the idea behind the 1998 Asian financial crisis.

Blogger DonReynolds April 06, 2018 1:38 PM  

If people want to talk about trade war, then keep the talk about trade .... buyers and sellers. The international flow of capital is not trade.

If you are the seller (like China) your only effective weapon is embargo. Stop selling to people in order to deny them the benefit of what you sell. This can work fine if you are the only seller of an essential good (like food or energy or "strategic materials") but you only exclude yourself from the dance if other sellers are more than happy to sell to your customers. There is very little we get from China that we cannot buy from somewhere else. (China actually has considerable competition from even lower wage countries.)

If you are the buyer (like the USA), your most effective weapon is a boycott. Half measures to constrict trade can be somewhat effective too. You can impose import taxes (tariffs) or you can establish restrictions on the number of units that can be sold or you can raise the standards for quality of the imported items. The USA actually has considerable experience with this and already knows how it will turn out....think of the import automobile business. One of the main achievements of restricting the import of automobiles was to make cheap imports into luxury (priced) cars.

(My first Honda automobile, I bought new for $1,810 in 1972, which was hundreds of dollars cheaper than the Volkswagen beetle or super beetle.)

Blogger 罗臻 April 06, 2018 1:54 PM  

Falling dollar ~ credit inflation ~ global growth
Rising dollar ~ credit deflation ~ global recession

The dollar is the denominator of debt. Dollars are created and sold when there is growth, the debts are repatriated and dollars destroyed in recessions. We have been in a disinflationary depression for 10 years because credit growth is still far below the prior economic expansion. China has been inflating like crazy to keep its economy growing, but its yuan debt is implicitly backed by FX reserves, including all those treasuries. It is inflating like a madman against a disinflationary global financial system.

China's ratio of M2 to reserve is less than in countries such as Thailand, Indonesia and Malaysia in 1997. Their currencies imploded. China has greater restrictions on its capital flows, but structurally it is in a very weak position with the yuan at 6.3 to $1.

Also, the USDHKD exchange rate is approaching the peg limit. At some point, speculators may begin a run on the HK dollar and HK will be forced to sink their economy (pop their housing bubble) by hiking interest rates, burn through dollar reserves, or break the peg. This situation is an outgrowth of China's dollar problems.

Blogger Snidely Whiplash April 06, 2018 2:26 PM  

This comment has been removed by the author.

Blogger Snidely Whiplash April 06, 2018 2:26 PM  

The other side of China's dollar problem is the Seattle housing bubble. Chinese investors trying desperately to protect their money have pushed the average price of a house even in the Black neighborhoods in Seattle $650,000.
This is after Vancouver BC froze them out of the market by imposing a 15% fee on non-Canadian deed transfers.

Blogger 罗臻 April 06, 2018 2:45 PM  

Snidely, they reverse assimilated the Vancouver housing market: B.C. court ruling foreshadows flood of litigation, forced sales involving Chinese home ownerships, lawyer says.

It's a legal nightmare, there's all sorts of shady funding from Mainland China. I won't be shocked if it turns out they've rehypothecated houses.

Blogger Wormwood April 06, 2018 3:03 PM  

China has to convert yuan into dollars to maintain the currency peg. China is going to let it's currency float? An exclusively export nation is always a slave nation.

Blogger Ominous Cowherd April 06, 2018 3:25 PM  

Snidely Whiplash wrote:The real threat is a bond market dislocation, where it becomes impossible for the US Treasury to sell bonds, either because of trust issues, or because the market-determined interest rate is too high for the US government to actually be able to pay. We are several decades into a pattern of selling bonds to pay the interest on the bonds sold previously.

Yes. That pattern hinges on falling interest rates. They aren't going to fall much more, so that pattern is going to end eventually, regardless of China.

The Treasury can always sell bonds to the Fed, although that will eventually erase the fiction of Fed independence. Monetizing debt like that never ends well, but that doesn't mean they won't be forced into doing it.

Whatever the Fed does is going to cause a disaster. They can keep rates low, but that blows up the TBTF pension funds and insurance companies. They can let rates rise, but that blows up every over-leveraged borrower, like most government entities in the US and most US and international corporations. The good options are far behind us, and the only options in the future for monetary policy are grim.

Snidely Whiplash wrote:virtually their entire financial system is leveraged off of Treasury bonds. Reducing the value of the bond portfolio by even 10% would seriously endanger essentially every Chinese bank.

Is there a limit to how long the Chinese could keep zombie banks afloat? Is it shorter than the remaining lifetime of the current dictator? The Japanese have managed to extend and pretend for decades now, so don't rule that out for China.

Snidely Whiplash wrote:China would likely survive, but the people in charge in China would have their portfolios wiped out.that's why they won't let it happen.

Here in the US we see the ruling classes using funny money to loot the productive classes of hard assets. Given sufficient time, the Chinese rulers will no doubt make similar arrangements. I'd say they won't let it happen until they're ready.

Blogger Ominous Cowherd April 06, 2018 3:31 PM  

罗臻 wrote:... HK will be forced to sink their economy (pop their housing bubble) by hiking interest rates, burn through dollar reserves, or break the peg.

I thought that Hong Kong had a currency board, which never issued six HK dollars unless it had first taken in a US dollar? If that's the case, the peg could never be broken.

Blogger 罗臻 April 06, 2018 5:38 PM  

HK has more than 100% coverage with foreign reserves, but it maintains a currency peg. It has not raised interest rates along with the Federal Reserve. You can borrow (sell) HKD and buy USD and earn a higher interest rate with no currency risk (assuming they don't break the peg). The USDHKD did not approach the peg limit during the 1997 Asian Crisis, but it is approaching it now.

HK's problem is that it broke the trinity. You can control one thing: interest rates, exchange rate (peg) or an open capital account. HK has a peg and an open capital account, but it is trying to hold interest rates down to protect their housing market/economy.

Blogger 罗臻 April 06, 2018 5:40 PM  

Should be a closed capital account. Since HK has a peg, it should have an open capital account and market interest rates, but they're trying to control two variables. The market is calling them on it.

Blogger Daniel April 06, 2018 9:04 PM  

That would render the dollar useless and some mayor oil producers would stop accepting it as payment. Would enter a death spiral

Blogger Thucydides April 07, 2018 12:51 AM  

I wonder about the true state of China's economy. Although it has become almost an annual sport in predicting China's imminent collapse, we have known for many years that the reporting of Chinese economic data is...incomplete...to be charitable.

Lots of evidence exists that Chinese economic data has been doctored. We see direct evidence like spending massive amounts of resources to build "ghost cities", and reporting of empty commercial districts in Chinese coastal cities (evidently overbuilding to maintain the fiction of economic growth. There is also indirect evidence such as trying to parse Chinese steel production, since the reported consumption of coal, iron ore or electricity does not add up. Similar malreporting exists in other economic metrics like electrical production/consumption.

So while President Trump can squeeze them hard over unfair trade practices and their support of the DPRK, I doubt they will trigger anything as drastic as dumping US treasuries simply because their real numbers would never support such a dislocation. Indeed, even the current rounds of tariffs may unhinge the Chinese economy far more than they are willing to admit (or may apply enough asymmetric pressure that it triggers a crisis greater than either the Chinese or even the United States had anticipated).

In that case, all bets are off.

Blogger jdgalt April 08, 2018 12:02 AM  

If Trump really wants to piss off China, he should resume recognition of Taiwan and negotiate to build an American navy base there. China has said that they would respond by breaking diplomatic relations with us, but they need our trade much more than we could ever need theirs.

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