The Chinese-official-says-something-worrisome-about-the-dollar-or-Treasuries scare has by now become a pretty regular market phenomenon. What was new about Prime Minister Wen Jiabao’s blunt words today were that they were blunter than usual, and that they were being spoken by Wen Jiabao, not a “high-level state economist” or “the government’s foreign exchange regulator.” A sample:
We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.
He’s right to be worried, not so much about whether the U.S. Treasury will make its payments but about how much the dollars in which those payments are made will actually be worth in the future. But what’s he going to do about it?
The immediate answer is not much. China can’t sell any significant part of its $1 trillion or so in Treasury and agency (Fannie-Freddie-Ginnie) debt without tanking the value of its remaining holdings. It’s a variant on the old saw: owe the bank a thousand dollars and it’s your problem, owe the bank a trillion dollars and it’s the bank’s problem.
At the same time, the status quo of the past 6 or 7 years, in which China runs gigantic trade surpluses with the U.S. and then lends the money back to the U.S. to keep American consumers buying, simply can’t continue. Or maybe it can, but that would be a road to even bigger financial disaster than the one we’re having right now.
I’ve now been pretty much persuaded by Martin Wolf’s argument that unprecedented flows of capital from China and other big exporters into the U.S. (with unprecedent U.S. trade deficits as the flip side) were the single biggest cause of our current financial mess. Those global imbalances, as the aficionados call them, have got to be balanced out. There are two ways to do that (and I’m still mostly channeling Wolf here): One is for the nations of the world to stop trading with each other and investing in each other, which would wring out those global imbalances while also bringing on perhaps the worst global economic downturn ever. The other is for us and China and India and Japan and Western Europe and a bunch of other countries to figure out a way to keep the global economy going that doesn’t involve U.S. consumers perpetually spending more than they earn and Asian economies perpetually making more than they consume. Which will, if successful, eventually lead to China buying far fewer Treasuries for Wen Jiabao to worry about.