“Failsafe” and “Too Big to Fail” — #3

There are many good reasons to do what it takes to come up with a financial system that’s “fail-safe.” One of the best is that then maybe China will keep investing in America.

A recent article in the New York Times magazine, The China Puzzle by David Leonhardt, talks about how intertwined America’s economy is with that of China. I find it really scary, even though it ends on a hopeful note.

Some selected quotes:

“Over the past decade, China and the United States have developed a deeply symbiotic, and dangerous, relationship. China discovered that an economy built on cheap exports would allow it to grow faster than it ever had and to create enough jobs to mollify its impoverished population. American consumers snapped up these cheap exports — shoes, toys, electronics and the like — and China soon found itself owning a huge pile of American dollars. Governments don’t like to hold too much cash, because it pays no return, so the Chinese bought many, many Treasury bonds with their dollars. This additional demand for Treasuries was one big reason (though not the only reason) that interest rates fell so low in recent years. Thanks to those low interest rates, Americans were able to go on a shopping spree and buy some things, like houses, they couldn’t really afford. China kept lending and exporting, and we kept borrowing and consuming. It all worked very nicely, until it didn’t… The most obviously worrisome part of the situation today is that the Chinese could decide that they no longer want to buy Treasury bonds.” [Emphasis nervously added]

“Were China to cut back sharply on its purchase of Treasury bonds, it would send the value of the bonds plummeting, hurting the Chinese, who already own hundreds of billions of dollars’ worth. Yet Wen’s comments, which made headlines around the world, did highlight an underlying truth. The relationship between the United States and China can’t continue on its current path.” [Emphasis added]

“Throughout most of the 1990s, China’s current account surplus — the value of exports minus the value of imports — equaled less than 2 percent of its gross domestic product. As late as 2001, this surplus was only 1.3 percent of G.D.P. But then it began soaring. Last year, it was 10 percent of G.D.P., according to the World Bank. In more concrete terms, China sold $338 billion worth of goods to American consumers and business, more than the combined annual revenue of Microsoft, Apple, Coca-Cola, Boeing, Johnson & Johnson and Goldman Sachs. [Emphasis added!] American businesses sold only $71 billion to the Chinese.”

“At the end of a discussion with Lardy [Nicholas Lardy, a China expert at the Peterson Institute for International Economics in Washington] about the imbalances between the U.S. and China, I asked him what forms of leverage he thought the Obama administration had. ‘We have no leverage,’ he replied.”

A recent story in The Business Times says that China is still buying, and as of March had $767.9 Billion in Treasuries. That may not sound like a lot of money to you these days, but I’m still working on my first $1 million!

Leonhardt’s concern is that inflation caused by our stimulus packages will bring a decline in the value, and thus the desirability, of the Treasuries. Might happen.

MY concern is that the Chinese might also recognize that the American economic system is inherently unstable, since we’re still allowing (and indeed encouraging the growth of) financial institutions that are “Too Big To Fail.”

And have you read The Black Swan about unlikely events that aren’t planned for? And do you know about chaos theory, how sometimes things don’t end with a whimper, but with a bang?

And so if AMERICA remains “Too Big To Fail,” then a sensible policy by the Chinese would be to pull out, slowly if possible, more rapidly if necessary.

I’m for a “fail-safe” financial system. Now.

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