First, a disclaimer. Getting rid of bad loans to the US government is not a must. It is not inconceivable that foreign governments, central banks and sovereign wealth funds, and even foreign companies and individuals will be just happy to lose most of their dollar hoard provided that they lose it gradually, 3-4% a year, year after year after year. The assumption that people are stupid works too often, in fact, it works most of the time, and governments, if anything, are even more stupid than the people. In addition, taking this position is a natural choice for you if you're an official in a banana republic and want to win friends in Washington, DC. There is no sure way to gauge the degree of stupidity and corruption in third-world countries holding US debt, so it is uncertain when the bank run on the US bond system will take place and whether it will take place at all.
If we assume some healthy instincts on the part of these foreign entities, the only question is the timing of their exit from US bonds. There are many excellent reasons for them to dump worthless US debt, but the basic reason is that they have now reached the point where any further accumulation of debt becomes self-defeating because the debt loses its value at a faster rate. To take a simple example: if you save $1000 a month and your bank pays you interest that is 3% below the official inflation, then during the first year this rip-off is not a major concern. You're losing 0.25% a month in terms of purchasing power, but after the first 10 months of saving, your savings still grow 10% a month. Suppose now that you've accumulated $400,000 in that bank. Well, now your saving activity is equivalent to pouring water into a leaking pot because you're losing purchasing power at exactly the same rate as you add new liquidity.
For sovereign wealth funds, who own some 3 trillion dollars, this moment is dangerously close. They should be making 10% a year to maintain their purchasing power, but Uncle Sam is reluctant to pay more than 4%. This means SWFs are losing some $180 billion a year in real terms. But SWF are only the tip of the iceberg, which also includes fixed-income dollar assets of central banks, government reserve funds, state-run companies, private companies and individuals. It is time to consider a change of strategy.
The need is not equally strong for all countries. Oil exporters will have a chance, indeed, will be forced, to consume all their savings when oil drops. As far as they are concerned, even a leaky pot can perform its stabilizing function. Holding bonds is still a terrible idea for these countries, and they should be diversifying into stocks instead, if only because S&P and oil are countercyclical. But at least they have a shorter time horizon, so if they're going to use the money in 5-7 years, the US Treasury will not steal all their savings though inflation. It will steal only 25-30% of the total. For China and Japan, however, there is no chance to use their cash hoard efficiently at the trough of the economic cycle. Being immune to extreme cycles that reduce OPEC economies to feast-to-famine stories, these countries will not experience such deep troughs down the road. To these countries, an SWF is a future generations fund as opposed to a cash hoard for a rainy day. If their economies grow sick, it will be a chronic malaise rather than an acute crisis. Moreover, if there is one thing that threatens their economies, it is the practice of paying an annual tribute (crossed out), subsidy (crossed out), stupidity tax (Finally! That sounds right!) to uncle Sammie. For these two countries that intend to hold on to their savings for 20 years or longer, it will be a terrific idea to get rid of treasury slime almost at any cost.
Here is the situation. You're an export-oriented country (let's say, China), and you sell tons of consumer goods to America. As a result, you run trade surpluses and your exporters bring in tons of dollars. You want to keep your domestic currency weak, so you print billions of renmimbi with which you buy the dollars, and then you deposit the dollars into US T-bills or the FNM / FRE bonds. You think you've become rich because you own some two trillion dollars worth of bonds. You think you must sell your consumer goods to America because that where your largest market is. You think you cannot sell your consumer goods to the locals because the locals are too poor to buy them. As long as you believe in the intrinsic value of the dollars you hold, things look fine. [more]
TDRH responds to DWI's post, asking him if he thinks that "the poor in the third will be better off for having us as company." I think the answer is yes. [more]
Hmm, so what happened to the postindustrial economy? The American global leadership, technology, benefits of globalization, and, last but not least, resilience (yes, how could I forget this buzzword?). One small increase in the price of oil, and thousands of US stock tumble like rows of plastic soldiers under a gust of wind? There's something very embarassing about it. Just think, the mighty S&P dies of expensive oil! Kind of like Napoleon's Grand Armee intending to march all the way to India, only to get infested by lice while crossing the first Lithuanian river on its way. [more]