The implications of a reduction of Chinese holdings of US government debt

Dear Readers,
Below is my response to a reader of my blog, who asked about the implications of China reducing its holdings of US treasury debt.
Pat Barron
Dear Lawrence,

I think that in the simplest terms, China is exiting the market for US Treasuries, which means that the US government must offer a larger yield in order to entice buyers who are still in the market to make up for the loss of Chinese demand. That means that US interest rates would have to rise, because the T Bill is the base upon which all other rates are set. Why would someone buy a corporate bond at a lower yield when he can buy a T Bill, which has less risk, for the same or even higher yield? Alternatively, the Fed could monetize the debt, which would cause US prices to rise (eventually) due to the increase in the money supply.
I have contended for some time that this event would lead to a crisis. When the world market eschews T Bills, the government is left with difficult choices. It can raise taxes to pay off the debt that it can’t roll over. It can cut spending to decrease the amount of debt that is required to fund all the government’s programs. It can increase interest rates to suck more money out of the private economy and into government bonds. Or it can monetize the whole thing. Of course, it could do a combination of all these things. My least favorite option is that the government monetizes the debt; i. e., prints more money. My favorite option is for government to drastically reduce its expenditures, but this is probably the most politically difficult option.
Pat
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My letter to the Financial Times, London re: The FT sides with counterfeiters and confiscators

Re: The case for retiring another barbarous relic

Dear Sirs:
I was appalled at your supposed “case” for eliminating cash, which you yourselves describe as the peoples’ “go-to safe asset”. And what IS your case?
One, “cash…limits the central banks’ ability to stimulate a depressed economy.” Really? Although I am not in favor of debasing money as a path to prosperity, I see no limit to the central banks’ ability to hit the “enter” key on their computer screens in order to manufacture out of thin air as much money as they dare. Two, banks cannot impose a negative interest rate–what we common folk call stealing–on the cash in one’s pocket. Your preposterous goobledygook that a negative interest rate is required by central banks in order to have sufficient “ammunition” when tightening from a “lower band” is as vacuous a statement, although often heard, that one can imagine. Three, that unlike electronic money, cash cannot be tracked…to which I answer “so what?” and “thank God for that!” Four, that former chief economist of the International Monetary Fund, Kenneth Rogoff, thinks eliminating cash is a wonderful idea. Let’s set the record straight. The IMF gets its money from sovereign states, who tax their people against their will in order to give the money to the IMF to squander and give bad advice around the world. Any self-respecting economist would try to hide the fact that he had anything to do with such an institution; therefore, I find little comfort in Mr. Rogoff’s endorsement of the cash-confiscation scheme. Four, the state can more easily levy a Value added tax in order to make tax collection easy. Oh, how nice! Here…let me put my cash in the bank in order to make it easier for government to tax it away. Ah, but then you conclude your support of the cashless society with the caveat that we minions might, just might, be allowed to carry some cash…but at a cost. Our cash could carry an expiration date, for example. As you state: “The benefits of cash are significant–but they need not be offered for free.” A more Orwellian statement would be hard to find.

 

Patrick Barron

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My letter to The Times, London re: Legal Tender Laws Protect Unsound Money

Dear Sirs:

I will not take the time required to refute point-by-point Mr. Ed Conway’s latest attack upon a gold-backed currency. It is obvious that he is completely ignorant of monetary theory and history. Rather, I will ask Mr. Conway why governments must erect legal tenders laws around their fiat currencies, using the police power of the state to force citizens to use their currencies? The answer is obvious: were it not for legal tender laws, sounder private monies would drive governments’ fiat monies out of the market. I do not advocate a gold-backed, government currency, because I know that all governments will suspend specie redemption for any myriad of reasons, all of which can be placed into two general categories: fund wars or buy votes with welfare payments. Only private monies can be trusted, because they would be subject to the rule of law. Money issuers who did not surrender specie upon demand would be declared bankrupt and thrown in jail. When governments do the same thing, they are lionized as patriots and philanthropists of the public purse. I repeat–if Mr. Conway believes in the superiority of government issued fiat money, then abolishing legal tender laws would have no effect upon the pubic’s demand to use government money. I dare Mr. Conway to recommend such a policy.
Patrick Barron
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Oh, the horror of cheaper Chinese goods!

Re: Cheaper Chinese Currency Has Global Impact

China’s money dictators have decided to put all Chinese exports on sale, allowing people in foreign countries to buy more Chinese goods for the same amount of local currency or invest in any manner of other financial transactions that will increase their quality of life including (dare I say the name?) saving! Oh, the horror of it all.American politicians are fretting that prices actually may fall, benefiting everyone from the unemployed to the rich. This, my friends, is a situation that cannot be tolerated, for the politicians’ supporters in industry do not wish to allow their fellow Americans to enjoy a higher standard of living. Oh, no. We Americans must pay higher prices for fewer American goods of lower quality. This is the path to prosperity. If you cannot understand this logic, then it is obviously that you do not have a degree in economics from a large American university.

 

Patrick Barron

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My letter to the Wall Street Journal re: A strange definition of “good news”

Re: Consumers Prime the U.S. Pump

Dear Sirs:
Your definition of “good news” for the U.S. economy is defined as an increase in “real, or inflation-adjusted, personal-consumption expenditure”, which was driven by a “savings rate, which slipped to 4.8% from 5.2%.” An economy can expand only from savings; i.e., deferring consumption in order to invest capital resources in productive assets that will provide more goods in the future. Your definition assumes the opposite. Surely, you would not recommend such a policy for individuals: i.e., that one should spend one’s savings in order to be more financially secure in the future. And, please, do not resort to the fallacious argument of the “paradox of savings” and/or the “savings glut”, which assumes that what is bad for the individual somehow is good for the economy as a whole.
Patrick Barron
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My letter to Wolfgang Munchau of the Financial Times, London

Re: The make believe world of eurozone rules

Dear Sir:
In your otherwise fine column today–Monday, July 27, 2015–you conclude with this statement:
“…Germany does not want to grant Greece debt relief for political reasons, and is using European law as a pretext.”
Earlier in your column you pointed out that Article 125 of the European Treaty on the Functioning of the European Union prohibits countries from taking on other members’ sovereign debt. You criticize–rightly, in my opinion–the ECJ for ruling that this very clear prohibition can be violated. You then point out that the German Constitutional Court twice had not supported the ECJ’s position. It seems to me that the German view can be interpreted as a defense of the rule of law, which your column says has been ignored by the ECJ, and that Germany’s objection to another bailout is more than merely a political pretext. Not only has the violation of the rule of law by the EU led to the Greek financial crisis, it strikes at the heart of Western civilization.

 

Patrick Barron

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Economic Fallacies about Greece

There has been much unscientific economic pronouncements about Greece’s financial problems and especially how to solve them. Below is a short list of three of these economic fallacies.

 

  1. The euro is too strong a currency for Greece.

 

This statement usually is accompanied by a reference to Greek productivity being lower than that of the northern tier EU countries. The logic, such as it is, states that the euro is not a suitable currency for countries with vastly different levels of productivity. This is followed by a recommendation that Greece leave the European Monetary Union and reinstate the drachma. The National Bank of Greece then would set a very low exchange rate between the drachma and the euro, making Greek products more competitive.

 

Well, there is a semester’s worth of economic fallacies embedded in this chain of logic. A currency is an indirect medium of exchange. Two countries with different levels of productivity can use the same medium of exchange just as two individuals can do so. You may pay the kid next door to mow your lawn with dollars that you earned in a highly skilled and highly compensated profession. Yet you both use dollars. There is no reason that the Greeks and the Germans cannot use the same currency. In the age of the gold standard, national currencies were defined by their exchange rates to gold and were redeemable in specie; therefore, in effect, all countries were using the same currency– gold.

 

  1. Debasing the currency will help the Greeks export their way to recovery.

 

Correlated to the above fallacy is the notion that debasing the currency will aid the Greek economy by the stimulative effects of an increase in exports. The idea is that the Greeks can give more drachma for the currency of its trading partners, making Greek exports cheaper in terms of the foreign currency. Increased exports will stimulate the entire economy. But currency debasement merely causes a transfer of wealth within the monopolized currency zone. The Cantillon Effect tells us that the early receivers of the newly printed money benefit by their ability to purchase resources at existing prices. The losers are those furthest removed from the initial increase in spending, such as pensioners. They will find that their money doesn’t buy as much, due to price increases that are an inevitable consequence of an increase in money spending. Eventually the exporters find that the cost of their resources has risen, at which point they demand another round of money debasement in order to prop up foreign sales and avoid business losses. They will be forced to pay more for their factors of production and must raise prices in local currency terms. In order to avoid losing sales they need their foreign buyers to receive more local currency so that their goods do not increase in price in foreign currency terms. This policy masks real structural problems. It is not a currency problem.

 

  1. Instituting one’s own currency will enable government to avoid unpopular spending cuts.

 

In other words, debasing the currency is a way avoid the dreaded austerity monster. Governments would have the people believe that there are sufficient real resources to redistribute from the wealthy to alleviate all poverty. It is assumed that the wealthy have nefariously confiscated the people’s wealth, and redistributing it along socialist lines will result in plenty for all. The socialist “plenty for all” slogan has been around a long time and has yet to prove its worth in alleviating poverty.

 

The Greeks (and Europe) Need Monetary Freedom

 

In conclusion, too much of the commentary about the Greek crisis has focused on whether or not Greece should drop the euro and not enough on the structural problems arising out of decades of socialism. The Greek government has borrowed more money than the Greek people can possibly repay. Debased money will not make this fact disappear and, on the contrary, will cause even more harm. It is telling that in poll after poll the Greeks themselves show that, although they do not desire austerity, they also do not wish to abandon the euro. They know that such a move will allow the government to destroy what little wealth remains in the country. The Greeks see the euro, with all its flaws, to be superior to a reinstated drachma. The best alternative for Greece right now is to abolish legal tender laws, which would allow the Greek people to trade in whatever currencies they deem most desirable. The Greek government may be forced to default on its euro loans. It is hard to imagine what good can come from another bailout just as it is hard to imagine what good can come from harnessing the Greek people to the yoke of high taxes. The Greek government itself responded rationally to the structure of the European Union and the European Monetary Union. It borrowed heavily at low rates of interest from willing lenders. It accepted all the newly printed euros so eagerly offered by these flawed organizations’ various funds. It is not the only country to do so, merely the first in which the adverse consequences of the EU’s flawed structure became apparent. There will be others and the adverse consequences will be greater. What is important now is that Europe stop destroying its capital base in pursuit of a socialist dream that has become a nightmare.

 

Patrick Barron

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An economic myth that just will not die

An excerpt from today’s Open Europe news summary:

Luc Coene, a member of the ECB’s supervisory board and a former Belgian Central Bank Governor, told Belgian daily De Tijd that a Grexit may have been a better option, arguing, “Because of the depreciation of the currency, one can achieve more through increased exports in a less painful manner.”
No. Debasing one’s currency does NOT solve anything. There is no way that a country can force others to subsidize its economy through debasing one’s own currency or that one can “jump start” or “stimulate” one’s own economy by debasing the currency. All currency debasement accomplishes is a transfer of wealth from the non-exporting sectors of an economy to exporting sectors and foreigners. In other words, increased exports are subsidized by one’s own citizens.
Patrick Barron
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The depth of the European problem is starting to get attention

From today’s Open Europe news summary:

William Hague: Greek crisis could be only the beginning

Writing in The Daily Telegraph, former UK Foreign Secretary William Hague argues that “this is not just about one country. It is in Greece that the fundamental tensions created by a single currency have first broken through, because Greece is a particularly indebted and less competitive country. But the same tensions will ultimately surface in other nations facing a less immediate crisis but a similar prognosis.” He adds, “There is a clear risk that the economic performance of the south will diverge from, not converge with, the north. Unless this is averted in the coming years, it will bring problems to Europe for which Greece has only been a minor rehearsal.” His comments resonate with an op-ed written by Open Europe Co-Director Stephen Booth for The Daily Telegraph last week, in which he argues that the Greek crisis shows the need to redefine ‘ever closer union.’

Hague believes that the problem is the old “north-south” issue, whereby the northern countries supposedly are industrious and productive and the southern countries are not. But this is not the case, because productivity is a relative term. The problem is the structure of the European Union, which gives an implicit guarantee by all members to honor whatever profligate debt any of its members may incur. Greece is just the tip of the iceberg, the canary in the coal mine. No one in Europe quite yet seems to be willing to admit that it is foolish to place entire nations on welfare. The real instigators of this problem are the European socialists, who just cannot bring themselves to recognize that socialism will not work, even if practiced on a grand, continent-wide scale with the ability to print fiat money in vast quantities. I humbly disagree with Mr. Booth that the Greek crisis shows the need for an “even closer union”. It shows just the opposite. Each sovereign nation must balance its own books and live within its means. No collective of nations will be willing to tax its own citizens to support the lifestyle of the citizens of other nations for long, which is what the “ever closer union” implies.
Pat Barron
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Greece should repeal legal tender laws and not print drachma

From today’s Open Europe news summary:
Ruparel: Greece is going to have to start printing its own money

Open Europe’s experts have been widely cited in the UK and international media discussing the latest developments in the Greek crisis. Writing for The Daily Telegraph, Open Europe Co-Director Raoul Ruparel argues that “The negotiations may rumble on for a bit but the gaps between Greece and creditors as well as within the creditors look too large to bridge. Ultimately, if Greece ever wants to reopen its banks it will have to start printing its own currency, marking an important step towards full Grexit.” Raoul also appeared on BBC Radio Four’s Today programme and on BBC Radio Two’s Jeremy Vine Show arguing that it will be very hard for Greece to avoid leaving the Euro now, since its demands remain incompatible with the political situation and democratic mandates of most other Eurozone governments. Raoul is also quoted by the International New York Times and El País. Open Europe’s Co-Director Stephen Booth is quoted by Die Welt arguing that Grexit would reinforce David Cameron’s argument in favour of a more flexible EU.

With all due respect I most vigorously challenge Mr. Ruparel that the Greeks should start printing their own money. Greece should repeal legal tender laws, as a starter, and allow the people to use whatever money they deem most useful. There is little doubt that the world, including the Greeks themselves, will have no confidence in a new drachma; it will be worthless upon arrival.
 
Pat Barron
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