Scot Mcphee on Sat, 27 Dec 2008 01:06:27 +0100 (CET)

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Re: <nettime> Dollar Shift: Chinese Pockets Filled as Americans Emptied

On 26/12/2008, at 8:19 PM, Felix Stalder wrote:

> [This is the last third of a NYT article about an issue I understand
> less and less. Why are the Chinese continuing to buy US debt particularly
> now that the yield is effectively zero? The short term logic is
> understandable and well explained below. To keep the system going.  But
> what about  the long term? Contrary to what this article suggests, I
> doubt that this  is going to last forever. But how is this going to
> break? Through massive inflation and much higher interest rates? This is
> all puzzling to  me, even if I suspect this is a key piece of the puzzle.
> Felix]


Yes I read that article last night (my time) too. Several things  
spring to mind.

In any crisis there is a 'flight to quality', in other words, people  
with cash seek to minimise exposure to risk. In a small crisis this  
might mean that smaller or risk-exposed companies suffer and large  
stable companies operating in sectors not regarded as affected (the  
sectors might vary according to the crisis). You will always find  
however that U.S. Government bond yields (effectively the interest  
rate the Government pays to borrow the money) fall.

In *this* crisis however, nearly everything is suspect. Just about  
everything in the financial sector is seen as practically junk- 
quality. Any company that is carrying debt, especially short-term debt  
that has to refinanced soon, might fail to refinance that debt because  
the banks won't lend it, well, that's not a desirable scenario for  
investors either. US housing markets are toast. Companies that sell to  
consumers are struggling to find consumers. The 'Macquarie model'  
infrastructure investment funds turn out to be not such great  
investments. And who needs services in this market? If you're trade- 
exposed you might go down because international trade flows have  
plummeted with the looming recession (see the Baltic Shipping Index).   
If you're an energy producer the oil price is below $40 and falling.  
If you're a metals producer no-one needs anywhere near the volumes of  
steel or aluminium that you just geared up last year to pump out (and  
just this year the Chinese pumped billions of dollars buying a small  
piece of Rio Tinto  and some other metals producers in order to stave  
off BHP's bid for RTZ, which BHP unceremoniously dumped last month,  
causing an already-falling and debt-laden RTZ to plummet and now the  
Chinese investment is not worth so much, they dropped quite a bundle  
on that little bit of national interest). OK, so equities are almost  
useless and commercial debt markets not worth the paper the debt is  
written on.

OK you've got some hundreds of billions of dollars in cash sitting in  
a warehouse out the back. Consider that the money isn't actually held  
in cash. You have to put it somewhere - banks are too risky, equities  
and currency markets too volatile. So you 'fly to quality', and the  
ultimate quality is the guarantor of just about everything, the U.S.  
Government and it's system of bonds, notes and bills. The U.S.  
Government needs the money both to underwrite it's welfare program for  
failed investment bankers, and to start a Keynsian re-inflation of the  
thoroughly deflated U.S. domestic economy. The Chinese need to ensure  
that their principle consumer doesn't go broke. And it's not just  
Chinese money that's flooding in. The Gulf States are also sitting on  
large reserves and these have to be parked somewhere too. In fact the  
'flight to quality' is so great, the amount of cash pouring into U.S.  
Government coffers so vast, that the 90 day T-bill pays practically  
nothing. In other words, "take my cash, I'm happy just to get it  
back". The money that the U.S. Federal Reserve pumps out to the banks  
pretty much goes straight to Government bonds. The U.S. Government is  
effectively printing money for itself. It's called 'Quantitative  
Easing', but you can just substitute 'Printing Money'.

Will this end up with massive inflation and subsequently, huge  
interest rates as you ask? Perhaps. As the housing bubble burst and  
everything else around it crumbled to dust, a corresponding bubble has  
been created in the bond markets as the U.S. Government employed  
'Quantitative Easing' to desperately re-inflate bank liquidity.  
Commercial paper is another story however, and usually measured by the  
"spread" between a Government bond and the target type of commercial  
bond or other debt instrument. These sorts of spreads between low-risk  
and high-risk investments have been skyrocketing recently, although in  
recent weeks most of these have backed off a little. Nonetheless,  
despite recent falls in LIBOR (London Inter-Bank Offered Rate, the  
rate that banks lend money to each other*), which indicates that  
surviving banks see each other as less of a risk, *volumes* have still  
be very low as most cash is now flowing to bond markets. The USA is  
hoovering up all the money. None of it sounds like it will end up  
prettily for anyone.

* slightly more complex than that but effectively this is the case.

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