Net Drain on US Foreign Reserves

Asia Times’ Julian Delasantellis article US Fed’s move is the bigger problem would be a brilliant piece if he didn’t continuously make the assumption that what caused the US financial crisis was an outgrowth of a lack of government rules and decrees (Please see Credit Expansion Policy and The Business Cycle). That gaffe taken aside, he makes a lot of good observations. In particular:

The first article I ever wrote for Asia Times Online, (US living on borrowed time – and money” March 28, 2006), introduced readers to the US Treasury’s monthly Treasury International Capital (TIC) report, a compendium of how much investment
or short-term capital the US receives from foreign sources every month. Back then, the US was quite the popular parking spot for foreign capital, frequently drawing in over $100 billion a month.

That worm has certainly turned; the US in January, the last month data is available, was actually net drained of foreign capital, to the tune of $150 billion. On his blog at the Council of Foreign Relations, economist Brad Setser interpreted the data this way.

Today’s TIC January data was a disaster. $150 billion in (net) capital outflows (negative $148.9 billion to be precise) cannot sustain even a $40 billion trade deficit.

Obviously, the concern is that those with still the capital to lend to the US, primarily China, seeing the huge increase in US government demand for borrowed funds with its now huge and ever-burgeoning budget deficits being used to finance the economic crisis recovery programs, will fear that the US dollars they use to buy US debt will depreciate in value, devastating the value of their investments.

Previously, China has tried to give messages that slowly pulling out of its dollar positions was exactly what it wanted to do, but America’s cherished habit of ignoring anything that foreigners say to it had it lending a stone-deaf ear to the warnings.

One can only hope that China will act in accordance with its rhetoric. A Chinese withdrawal from additional purchases of US Treasury securites will make the American people wake up to reality and understand the consequences of their government’s policy of inflation. When exactly this will happen is hard to determine. The current deflation may continue to go on for a very long time, in spite of all the Fed’s desperate attempts to reflate.

More on China-US relations in the US Current Account Deficit and in US on the Hook for Chinese Investments.

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China to US: We Hate You

The Chinese recently commented on their purchases of US Treasuries:

Luo Ping, a director-general at the China Banking Regulatory Commission, said after a speech in New York that China would continue to buy Treasuries in spite of its misgivings about US finances.

We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.”

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China Schools US on Capitalism writes China Blasts U.S. Economic Policy, Expresses Doubt in Financial System:

China blasted U.S. economic policy yesterday (Thursday) at the Strategic Economic Dialogue, a two-day summit engineered to address long-term issues between the two countries. Chinese authorities have grown more fervent, and more explicit, with their criticism of the U.S. financial system over the past year, evidence of a shift in the balance of power between the nations.

“Over-consumption and a high reliance on credit is the cause of the U.S. financial crisis,” said Zhou Xiaochuan, governor of the Chinese central bank. “As the largest and most important economy in the world, the U.S. should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.”

China schools the United States government about savings, trade balance, and fiscal responsibility, the essentials of sound capitalistic policy. They are stating exactly what needs to happen in order for the US to get out of its demise. Not once have we heard Bush, Paulson, or Bernanke suggest reducing fiscal deficits, saving more, borrowing less as a solution to this crisis. They are, in fact, encouraging the exact opposite! It takes the Chinese government to tell Paulson in his face. This truly marks a historical shift in global economic relations.

This kind of lecture was a deviation from past meetings, which were dominated by U.S. calls for China to better manage its fiscal policies. However, the global financial turmoil that has emanated from the collapsing U.S. housing market has left the United States without a pulpit on which to stand.

One result of the crisis is that the U.S. no longer holds the high ground to lecture China on financial or macroeconomic policies,” Eswar Prasad, a senior fellow at the Brookings Institution, told the Financial Times. “This may actually help turn their relationship into a more equal partnership with less posturing on both sides.”

Indeed, U.S. Treasury Secretary Henry Paulson, who in the past used summits like these to press Beijing to open its financial system and appreciate its currency, was noticeably more humble in representing the United States yesterday.

“International cooperation and coordination have been robust and we appreciate the responsible role China has played in the crisis,” he said.

Paulson needs China’s money badly. That’s what’s behind this humble tone.

Meanwhile, Wang Qishan, vice premier and leader of the Chinese delegation called on the United States to “take the necessary measures to stabilize the economy and financial markets as well as guarantee the safety of China’s assets and investments in the U.S.”

Wang’s remarks followed those of Lou Jiwei, chairman of China’s $200 billion sovereign wealth fund, China Investment Corp. (CIC), who said Wednesday that his firm lacks the confidence to invest in the United States, particularly U.S. financial institutions.

“Right now we don’t have the courage to invest in financial institutions because we don’t know what problems we will put ourselves into,” Lou said at a conference in Hong Kong. “My confidence should come from government policies. But if they are changing every week, how can you expect that to make me confident?”

CIC has lost about $6 billion of the $8 billion it invested in Morgan Stanley (MS) and The Blackstone Group LP (BX) last year. More importantly, however, China last month overtook Japan as the largest holder of U.S. government debt. And according to the Financial Times, officials have privately admitted that they are concerned about the value of the holdings.

Hopefully this teaches international investors a lesson: Don’t invest in US Banks. Leave it to Warren Buffet to burn his money on failing banks. The Chinese government will without a doubt have to get a lot more cautious about their holdings in US securities. The US central bank is in the process of creating a major Treasury bubble. This bubble will collapse. It may take 1-2 years, but it will happen eventually.

Concerned with China’s overexposure to the United States, central bank governor Zhou said policymakers should no only address the country’s slowing economy, but “restructure the development model” and prepare “for a worst-case scenario,” the FT reported.

However, Chinese officials also say that any large-scale unwinding of U.S. holdings would be counterproductive, as the value of U.S. bonds and the dollar would subsequently plummet.

If US fiscal policy doesn’t change significantly, once the next inflation picks up steam from the current money supply growth, the Chinese government will not have a choice but to dump its holdings of worthless US Treasuries.

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