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Disaster Averted? Not! The Back Story on the Debt Limit

This article was written by Peter Navarro and Greg Autry, authors of Death by China: Confronting the Dragon -- A Global Call to Action
 

It appears that our heroes in Washington have "saved" America by insuring that our government will borrow a great deal more money, much of which is sure to come from China. This Chinese money is apparently desperately needed to continue stimulating our economy into oblivion. 

A question lost in all the recent posturing and pontificating was, "Why would China be so eager to step up and buy more shaky debt from a nation that is clearly on the ropes?" It is a great question if you look at China as a rational investor seeking a reasonable risk / return ratio rather than a menacing competitor looking fro strategic advantage. After all, Friday's GDP numbers made it pretty obvious that with first quarter growth around 0.4% America has essentially never recovered from the 2007 recession and our economy has been on a fast track to nowhere for years. During this period, the biggest US corporations and investors have been flinging their capital at China where double-digit growth seems virtually endless. So, why don't the cadre's who run China invest their national savings in the good 'ol People's Republic (a term we use only with sarcasm) rather than fund a superpower in decline that China is clearly preparing to engage in military conflict?

You see, it is an extremely important but little known fact that China's currency peg -- the #1 trade cheat the Dragon uses to vacuum jobs out of the USA -- actually compels them to loan us money no matter how loudly they insist that that they have a choice of investments. It works like this: American's proclivity to take both the wages from our Democratic stimulus job and the checks from our Republican tax refunds down to Wal-Mart for another cart full of Chinese products, not only creates more jobs in Guangzhou than it does Milwaukee but also leaves China bursting with US dollars. The Chinese government then soaks up a lot of those bucks from companies like Huawei by selling short term, high yield bonds that pay back in Yuan. They then march those dollars right back to the US treasury. In fact, they pay MORE to get the dollars out of private hands in China than they earn on the increasingly risky bet they are making in US debt! At this point you should be thinking, "WTF?"

There is an explanation more believable than theory that Hu Jintao and Wen Jaibao love America and want to be of help to foreign barbarians in need. If China's firms were allowed to trade their dollars for Chinese Yuan on the foreign exchanges, the dollar would fall against the Yuan and undermine China's unfair 40% advantage against every American (and European and Asian) product. If they trade those bucks for some other currency, like the Euro, the dollar is still being sold and it still falls, plus China's growth draws a them right back in searching to buy Yuan, which would then rise. If China purchases products or commodities on the open markets, those dollars would still be exchanged, the greenback would drop to competitive levels, the Yuan would rise to its real purchasing power and Americans would go back to work making things. Wishing to avoid that horror of horrors at all costs, the Boys from Beijing must hold their noses and throw another billion good dollars after bad into the pit of the US treasury. Like Frodo's ring of power, the dollar can only be destroyed where it was created.

Economist Peter Morici has commented that China is now spending a full 35% of its export revenue or 10% of GDP on this "sterilization scheme." This explains why China's holdings of US foreign debt have leapt from 6% to 26% in the last ten years despite abysmal returns and the ever-increasing risk of default. It also bares the root cause of a trade deficit so massive that it alone has ripped ten million American jobs out of our economy over the same lost decade.

Another interesting thing is that if the Chinese currency is in fact seriously undervalued, the operation of such a sterilization process should be unsustainable, as it must undermine the purchasing power of the Yuan resulting in ever increasing consumer prices. Indeed this is exactly what we have seen as a most virulent inflation has seized that country despite repeated interest rate hikes and reserve requirement increases at China's banks. Wen Jaibao can deny this fundamental economic fact until he turns blue, but eventually the protests at home will pressure China's autocrats into pulling the plug on this operation. When that occurs you should probably go long on the Yuan and short on China's manufacturing sector just as fast as your mouse can carry you. You might even buy some stock in a firm that still builds stuff in America.

So when the President and the Congress reluctantly shake hands over this deal to avert disaster, understand that they have in great part only agreed to fuel the fire that has been burning down America's jobs factory for years, and thereby undermining government revenues and creating the apparent need for constant stimulus. 

So far, borrowing is the only way these folks of wee little imagination can see to sustain both the President's exorbitant level of spending and the Republican's stubborn pledge against tax increases. The obvious solutions eludes them, which is either to stop borrowing from communist criminals and borrow at higher interest rates from Americans, or slap a significant tariff on China until they drop their currency peg and illegal trade barriers. The tariff money would come in very handy now and the jobs even handier still. Certainly both these moves include downside risks, but what are those compared to the risk we assume by continuing to support China's engine of job destruction? The last decade of ultra low-interest rates, government stimulus efforts, and engagement with Communist China have clearly been an unmitigated disaster for the US economy.  Is anyone in DC listening?

 

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