Friday, April 08, 2005

An interesting piece of news in today's New York Times: We've gotten so used to getting Chinese exports cheap that, hey, we're hooked!

Just when, at least in theory, imports should be falling or at least leveling off in response to a dollar that no longer buys as much in euros, pounds and yens, they have continued to surge. Imports now equal 16 percent of the nation's overall economic output, up a full percentage point in one year. They represented only 11 percent of the gross domestic product a decade ago. But while imported finished goods like costume jewelry and clothing are what most people notice most, what they do not see is even more significant.

The biggest change is that American companies increasingly import many of the parts and components that go into the products they make in the United States, drawing on the global economy to supply what they once made at home.

To someone who's been following international currency chat over the past few months, this is kind of worrisome. But I assume you have better things to do with your time, so I'll try to explain:

Time was that people would complain that feckless kids didn't know the value of a dollar. But the value of a dollar is a more complicated subject than it used to be. In simple terms:

We are shipping vast quantities of dollars overseas to pay for imports, to a vast collection of countries that I'll refer to, for simplicity, as "China". And we aren't selling enough stuff overseas, paid for in dollars, to get those dollars back. (That is, we've got a trade deficit). The result, absent other action, would be an increased supply of dollars overseas -- and by the law of supply and demand, a drop in the price. (That is, the trade deficit tends to reduce the value of the dollar). But so far, there has been other action -- other governments, through their central banks, have been sending the dollars back here, not to pay for goods, but to pay for bonds -- Treasury bonds, mortgage bonds, whatever. So, over the short term, the value of the dollar relative to, say, the Chinese yuan doesn't change. (This is actually official Chinese policy -- the value of the yuan is "pegged" to the dollar, and their central bank acts to keep it that way. For the moment).

However, the bonds will eventually have to be repaid. At which point, the dollars that the Chinese paid for them will be going back to China. And the exact same problem -- the accumulation of a pile of dollars in China -- would happen again. With interest. So, the reinvestment does not deny the final reckoning, it just delays it.

The ideal scenario for us is that we find something that the Chinese actually want to buy with their dollars, and the problem takes care of itself. No one expects that to happen. The alternative is that the value of the dollar does, eventually, drop -- at which point, the value of China's towering pile of dollar-denominated IOUs will collapse, however high that pile has got.

But on the other hand, to preserve the value of their dollar-denominated stuff, the Chinese have to keep buying more -- adding to the pile, and making the ultimate damage worse.

Everyone knows this rigamarole can't go on forever. Even the ones who are trying to make it look sustainable by dignifying it with the name "Bretton Woods II". The question is, how does it stop, and when?

Economist Nouriel Roubini thinks the Chinese should pull the plug now, and pull it hard. Others, like David Altig, disagree -- they think that that would be too disruptive, and that mature central bankers will arrange a more orderly transition. (There's a debate here). But they seem to agree, at least, that the matter is in the hands of foreign central bankers, who will be looking out for their countries' interests, ahead of, say, ours.

So, what is the Chinese interest? Well, one problem with a sudden drop in the dollar, as I've already said, would be a drop in the value of their dollar-denominated bonds. But that problem is only getting worse, so it's hardly an argument for delay. The other big problem they'd face would be a decline in their exports to the U.S. -- that is, Americans would have to pay more dollars for Chinese products, and might then, say, turn back to American suppliers. But that assumes alternative American suppliers still exists. If they don't, which is how I started off -- it's much less of a problem. Our only choices would be to spend more dollars on Chinese stuff -- or make do with less for ourselves. And with the Chinese government wanting to turn themselves into the second superpower, either alternative may be just fine with them.

Oh, by the way, the Chinese Navy is starting to scare the pants off of ours.

The most extensive space exploration program probably still isn't theirs. It might be Japan's. They're piling up dollars too...


Anonymous Anonymous said...

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10:16 AM  
Blogger charles said...

I'm not at all sure why you're asking me, but both these types of bonds are the sorts of unusual transactions I'd look at with a pretty jaundiced eye, particularly when the web site advertising them is full of misspellings.

As for moving here, I can't guess at your personal circumstances and won't comment, but if you do, I would strongly recommend renting your domicile, unless you can afford to lose whatever you paid for the place you bought. Prices are dropping so fast that when this guy profiles some new loser property listing, he tosses in a "monthly equity burn" figure, which is usually in thousands of dollars...

11:27 AM  
Anonymous Anonymous said...

This comment has been removed by a blog administrator.

6:39 AM  
Blogger charles said...

In response to these questions, I'm not sure what "surety bonds" of any type are, but I would strongly suggest getting the advice of a licensed and reputable financial advisor before doing anything with them.

10:50 AM  

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