China has Cancelled America's Credit Card

In my March 19th post "Inflation Looms" it was obvious that the spending plans of the Obama administration would create a major funding abyss for the US. This is just the start:

By W.C. Varones ~ May 3rd, 2009 @ 7:34 pm

Congressman Mark Kirk says that China has “canceled America’s credit card.”

China, wary of the troubled US economy, has already “canceled America’s credit card” by cutting down purchases of debt, a US congressman said Thursday.

China has the world’s largest foreign reserves, believed to be mostly in dollars, along with around 800 billion dollars in US Treasury bonds, more than any other country.

But Treasury Department data shows that investors in China have sharply curtailed their purchases of bonds in January and February.
Representative Mark Kirk, a member of the House Appropriations Committee and co-chair of a group of lawmakers promoting relations with Beijing, said China had “very legitimate” concerns about its investments.
“It would appear, quietly and with deference and politeness, that China has canceled America’s credit card,” Kirk told the Committee of 100, a Chinese-American group.

“I’m not sure too many people on Capitol Hill realize that this is now happening,” he said.

I’ve been seeing signs of this happening for two years. It has taken far longer than I expected to play out. I attribute that to China’s illiquid portfolio conundrum. China knows that American Treasuries and the dollar are garbage, but as the biggest holder, it can’t dump them without destroying the value of its holdings, and at the same time destroying the ability of the American consumer to purchase Chinese exports.

Over the past couple years it appears China has been diversifying away from the dollar into other currencies, commodities, and equities, but not actually dumping Treasury debt. The problem now is that Obama’s deficits are so much bigger than prior years (and the off-budget bank bailout guarantees and Social Security and Medicare liabilities are so huge) that we need someone to step up and buy a whole lot more of our debt. That’s apparently not going to be China.

Hence Helicopter Ben’s plan for the Fed to print money to buy Treasury debt. That worked for a couple weeks. Note the sharp drop in 10-year Treasury rates in mid-march as Bernanke revealed his dastardly plan:

Yes, he shocked the bond market for a couple weeks into believing in cold fusion: Treasury can borrow and spend as much as it wants without causing higher interest rates because the Fed can just print as much money as it needs to buy all the Treasury debt. I’m sure that theory would make an award-winning paper at Bernanke’s Princeton economics department, but in the real world, it doesn’t work like that. Please see Zimbabwe and Weimar Germany.

So, yes, we still do need real buyers of our debt. Bernanke’s cold fusion only fooled the bond market for a couple weeks. Bond yields are now higher than they were before Bernanke announced his plan.

Our fiscal and monetary policy are the equivalent of children playing with matches around a gasoline can. China is the guy walking past who the kids ask for $100 to go get some more matches and gasoline. Trust us, we’re good for it.