March 13, 2010

The China Syndrome Counterpunch

Hatched by Dafydd

One fear that obsesses too many folks is that the People's Republic of China, a.k.a. Red China, "owns" a scandalous chunk of our national debt in the form of U.S. Treasury bonds; and that they will somehow be able to use these holdings to force us to dance to the tune they pipe, turning America into a Chinese vassal state.

When pressed on how they could physically do this, fearmongers suggest China could threaten to dump all their T-bills at bargain-basement prices, driving down the value of the bonds we need to sell to finance our out-of-control spending. The sudden drop in bond values would force us to jack the interest rate through the sky, just to get people to buy them. This in turn is supposed to drive our prime rate into the stratosphere as well, bankrupting the country.

To avoid this scenario -- dubbed the "China Syndrome" by some economists -- we will (so goes the argument) give the Commies anything they demand in the way of foreign and domestic policy and military stand-downs... to appease them, placate them, and keep them from carrying through their extortion.

Beldar has posted a fascinating (as usual) and long (as always) essay on the subject. He comes to the well-founded and irrefutable conclusion that there truly is little to fear from the fact that Commies hold such a huge amount of our debt:

A company's largest shareholder is not much at all like its largest bondholder. He who buys a company's bonds gets to stand at the front of the line, ahead of equity holders (like shareholders), if there's a forced liquidation of the company and a distribution of its net assets. But in exchange, the bond holder generally has to forfeit all rights to participate in the management of the company's business unless and until there's a default by the company on its promise to repay according to the terms of the bond. And the caselaw says that companies owe all sorts of fiduciary and other unwritten, vague, but powerful duties to shareholders, whereas companies own nothing more to their debt holders than the precise minimums to which the companies are specifically committed by explicit written contractual promises to the bondholders....

No matter how many Treasury bonds China buys, it can't somehow "convert" those into a right to cast votes in the U.S. Senate or to give instructions to the Joint Chiefs of Staff. The holder of an American federal bond has a contractual right, enforceable against the U.S. government under its own laws and in its own courts, to repayment of principal and payment of interest on the exact terms specified in the bond. And that's all it has. [All emphasis is in the original, except for this note that all emphasis is in the original. -- DaH]

But I have another angle on the whole thing. I say it would be absolutely wonderful for us if the Chinese really did enact their eponymous syndrome!

So why am I right and all those professional economists wrong? Because they think like acolytes of the Dismal Science -- that is, dismally -- whereas I think like a novelist.

Here is my scenario:

  1. Red China threatens us with a China Syndrome unless we sever relations with Taiwan (for example).
  2. We tell them to go stuff an eggroll.
  3. They decide to call our "bluff," and they really do dump all their T-bills at, say, half their current value.
  4. The Federal Reserve jumps into action, working through proxies to buy every dang Treasury Note China sells, as many as we can get our mitts on.
  5. Now that we have bought back hundreds of billions of dollars of our "debt" for fifty cents on the dollar, we wait for the dust to settle and the market to recover -- then we sell them again for the normal price.
  6. We send a letter to Beijing, thanking them for their generous donation to the Save Liberty and U.S. Sovereign Health (SLUSSH) fund. With heartfelt thanks, we settle back to enjoy our windfall profit on our own debt instruments.

The moral is simple: Whenever any entity -- whether individual person, giant corporation, or sovereign nation -- buys or sells bonds, equities, derivatives, collectibles, futures, or indeed any other investment instrument on the basis of politics, party, policy, or pique -- that is, whenever one makes investment decisions for any reason other than pure economics -- that entity is going to lose its shirt... along with its coat, tie, pants, and undies.

This Lizardian Rule of Thumb applies to universities that divest their stock in Israeli companies to protest Israel's dealings with the Palestinians; it applies to lefties who dump their mutual funds if they contain Starbucks or Nike stock; and it applies to conservative Christians who will only invest in companies that are run by ministers: You're going to lose a huge wad of your return by letting extraneous circumstances dictate your financial decisions.

Now you may think the trade off is worth it, and who could argue? Just bear in mind that you are donating beaucoup bucks to your favorite cause; if that's all right with you, I certainly don't care. So long as you are aware of what you are doing, and so long as you don't violate any fiduciary responsiblities you may have to shareholders (or moral duties to those who take your advice).

But I doubt that China is really that altruist. They're not going to donate hundreds of billions back to the U.S. just to make a political point. (That what? That they're too stupid to be trusted with monetary decisions?)

So let that be another reassurance that there will be no China Syndrome... at least until and unless we default on our repayment obligations, in which case dumping the bonds would be a purely economic decision anyway!

Hatched by Dafydd on this day, March 13, 2010, at the time of 11:09 PM

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The following hissed in response by: Steven Den Beste

You're ignoring the issue of exchange rates. What's missing from your scenario is that the dollar would collapse.

The above hissed in response by: Steven Den Beste [TypeKey Profile Page] at March 14, 2010 12:49 AM

The following hissed in response by: Steven Den Beste

A different point: your last step, " then we sell them again for the normal price." Sell them to who?

The reason the Chinese have been buying T-bills is that it's the only way for them to recycle dollars they've been accumulating due to the gross trade imbalance between them and us.

But after this kind of melt-down scenario, who would want to buy T-bills in those kinds of quantities?

The above hissed in response by: Steven Den Beste [TypeKey Profile Page] at March 14, 2010 12:52 AM

The following hissed in response by: Dafydd ab Hugh

Steven Den Beste:

What's missing from your scenario is that the dollar would collapse.

Not immediately; first we have to raise Treasury Bond rates; then the prime has to rise; then the high interest rates must have time to negatively affect businesses, especially small businesses; then a severe credit contraction must cause a business crash; and only after several months does the dollar collapse.

A different point: your last step, " then we sell them again for the normal price." Sell them to who?

Most of the debt is held by Americans and by European investors, especially from the U.K. The fundamentals of our economy are still sound; nobody is going to believe the artificially lowered rate for long. The main problem will be getting the chance to bid on the T-bills: Someone else might beat us to it!


The above hissed in response by: Dafydd ab Hugh [TypeKey Profile Page] at March 14, 2010 4:54 AM

The following hissed in response by: Necromancer

Yes to all on what you are saying Dafydd and the people commenting but you can bet your bottom dollar that the MSM and others of their ilk will print a lot of garbage to scare the devil out of the general population.And least we forget the talking heads I will not leave out.

The above hissed in response by: Necromancer [TypeKey Profile Page] at March 14, 2010 12:56 PM

The following hissed in response by: DK

Another factor: To buy those bonds at discount, we would have to elbow into the line ahead of George Soros.

The above hissed in response by: DK [TypeKey Profile Page] at March 14, 2010 3:23 PM

The following hissed in response by: Dafydd ab Hugh


Detain him for interrogation until the fire sale is complete, and we have all the bonds.


The above hissed in response by: Dafydd ab Hugh [TypeKey Profile Page] at March 14, 2010 7:06 PM

The following hissed in response by: Karl

Don't steps 4 and 5 depend on the Administration having the savvy to recognize the opportunity when it comes along?

The above hissed in response by: Karl [TypeKey Profile Page] at March 15, 2010 6:52 PM

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