Why Does It Matter If China Stops Buying Our Debt?

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U.S. GOVERNMENT DEBT

Will China stop buying our debt? Since, as a nation, we are spending more than we are bringing in from tax revenue, the U.S. Government must borrow money from others to pay for our spending. Currently, China and Japan are two of the largest purchasers of our government debt and many other countries simply don’t have the financial capacity to purchase as much of our debt as we need to sell. U.S. Government borrowing is

generally performed by issuing government bonds of different durations or maturities ranging from short term to as much as thirty years before maturing. That means that we get to use the money received from the sale of the bonds and only pay interest for the use of the money until the bond matures (short or long term) at which time the original amount borrowed is returned (typically by issuing new bonds that may have higher required interest rates). Interest has to be paid to the owner’s/investors in these bonds, just like interest has to be paid on your credit card. The interest rate that is due the investors is dependent on several things and may be higher or lower for short vs. longer terms depending on the “yield curve”. Historically, investing in the bonds issued by the U.S. Government has been considered about as safe as investment as you could possibly get. Indeed, during the recent financial crisis, many individual investors and other nations flocked to the perceived security of U.S. Government debt. However, the United States has a credit rating just like each of us. The credit rating can be perceived differently by different parties/countries, and individuals and foreign nations are discussing the possibility that the increasing levels of U.S. debt could place the nations AAA bond rating in jeopardy.

Just as your credit card company will increase your interest rate on your card if you have less than stellar credit, investors in bonds will also require a higher interest rate to buy your bonds if they perceive a higher risk of repayment. When this happens the U.S. Government has to offer higher and higher rates on the bonds to entice purchasers to buy them. Higher interest rates paid on U.S. Government debt means higher costs paid by the U.S. citizen to finance our country’s activities. We pay this higher cost through higher taxes.

Unlike your credit card, the U.S. Government doesn’t have a credit limit. Well, kind of. But if you could elect to increase your own credit limit on your personal credit card and effectively set the limit to any amount you wanted, would you really consider that a limit? While there is a current statutory limit on the amount of debt the U.S. can issue, our government can simply vote to increase the limit. They have done this in the past, and rest assured, they are about to do it again. Possibly multiple times in my opinion. Read here for a WSJ article on this very topic. What Mr. Robertson refers to in his video is the ability, or inability, of our government leaders to apply some self-discipline and rein in the increasing level of spending that they are implementing and suggesting. Note Mr. Roberson’s quote that “stimulate, stimulate, stimulate is synonymous with spend, spend, spend”. Based on your own past experiences and life observations, how much confidence do you have that your elected officials can exercise the political and financial self-discipline to rein in our spending and stop any and all unnecessary spending? If you are not 100% confident, please contact your elected officials in Washington and express your concerns. Also, please remember to vote! Your Senate and House political races are every bit as important as the Presidential race in my opinion.

Go here to see a related post regarding Inflation and Deflation

One result of the recent financial crisis and subsequent high levels of unemployment has been an increased level of savings by U.S. individuals and households. This is a good thing for us personally, but the timing could not be worse for the economy. As we save more, we naturally spend less and that is not necessarily good for restarting and growing our economy. When we buy fewer back-to-school clothes and postpone the 60-inch flat screen TV, or the new computer, the manufacturers and retailers suffer and the flow of money throughout our economy diminishes. This can lead to a self-fulfilling downward spiral that can have extremely severe consequences if not stopped. Stores and manufacturers go out of business, unemployment increases, people increase savings even more because they are scared, or totally unable to spend, more manufacturers and stores go under and so on and so on.

Historically, a large percentage of our Gross Domestic Product (GDP) has been driven by the American consumer. We now recognize (some recognized years ago), that much of this consumption/spending was being done with borrowed money from credit cards and home equity loans. Now that the American consumer has retreated, the only one left to try to get some money injected into our economy is our government. However, there is much argument that the government’s stimulus is only postponing the pain to come. Certainly any stimulus comes at a financial cost and must be financed and repaid by issuing more debt, raising taxes or both. This is exactly what Mr. Robertson is referring to.

MORE BAILOUTS AND STIMULUS TO COME

With all that has happened during the past 12-24 months it can be hard to keep our eye on the big picture. I would like to suggest the following for your consideration. Washington has already bailed out several industries and companies IN ADDITION TO the $787 billion stimulus. In my opinion, there is more to come. Fannie Mae, and Freddie Mac, two government-sponsored real estate entities already have capital surpluses below their required statutory levels and will most likely require another bailout. The Federal Deposit Insurance Corporation (FDIC), yes, the one that guarantee your bank accounts up to $250,000 is quickly exhausting it’s fund that pays for losses when a bank fails. 94+ banks have already failed, and some believe that 1000 could fail in the next two years! Already there is talk about accessing a $500 Billion line of credit that the FDIC has with the Treasury (more borrowing). Moreover, it is my opinion that the banking industry will, most likely, require another bailout even though some banks are already trying to repay the money from the first effort. I’ll write another post about this in the near future. You may want to consider the issues described in this paragraph as you determine for yourself the affordability of National Healthcare Reform that is not totally and verifiably budget deficit neutral in both the near and long term.

GEOPOLITICAL CONCERNS

Concerns about our federal debt should interest you for many reasons. I’ll address a few. When we as individuals, or business owners get in over our head with debt, it becomes harder and harder to borrow. When you get into a position of needing to borrow new debt to pay off old debt, you can only hope that you will be able to get that new loan each time. This borrowing of of new to pay off old has been how our government has financed our deficit for many years without problem. But as with so many other things, what you can get during good times, can be far different than what you can get during bad times. All of a sudden, your credit card company demands a higher interest rate and a larger monthly minimum payment. Both occur at once and when you are most unable to absorb the change.

As previously mentioned, China and Japan are two of the largest purchasers of our government debt. While we have good relations with Japan, I think it is safe to say that our relationship with China is, well, not as fully developed. While there is a need on China’s part to keep purchasing our debt, Mr. Robertson mentions that there are various circumstances that could impact their ability or desire to continue. Just this month, the our government tweaked some trade sanctions with China over automobile tires and poultry. There were small rumblings of protectionism etc. Just this week, we have seen the need to get China, as well as Russia, on board with our desire to implement meaningful sanctions against Iran. See where I am going with this. When we surrender our financial independence to a handful of foreign countries, our bargaining power with them on other issues, may be significantly impacted. Please follow/read/study about our federal deficit as often as you can and voice your opinions to your elected officials. I’ve just expressed a few of mine!

THE FLIP SIDE

Watch this CNBC video to contrast Mr. Robertson’s views. Here, CNBC’s Erin Burnett interviews three other Wall Street players for their opinions and comments about Mr. Robertson’s earlier statements. They appear somewhat more confident that we can avoid such a dire situation. It would appear that they are more comfortable with our government’s ability to apply the much needed fiscal discipline in a timely and effective manner. Additionally, they mention the idle funds that are currently sitting within American’s mutual funds and pensions funds and suggest that if foreign investors begin to reduce the level of their U.S. Bond purchases and rates go up, then domestic dollars will come in. Just remember, what is saved is not spent. ‘Tis a double edged sword.