Thanks, China (Maybe)

According to Bloomberg, China is considering whether to slow, or even stop, purchases of U.S. Treasuries. At $3.14 trillion, China holds the world's largest foreign exchange reserves. It is also the largest underwriter of U.S. debt. Financial experts and political observers have long worried that becoming financially dependent on an unfriendly and rival nation is not good for the U.S. in the long term.

In the short term, however, should Beijing choose to pull back its major underwriting of America's $20 trillion debt, it could force politicians to do something they have heretofore seemed incapable of doing: halt spending and start reforming or eliminating unnecessary and outmoded government programs.

Most of us who are not billionaires have had a "we can't afford it" moment when considering purchases for which we don't have the money. It usually doesn't take long before what was once considered essential becomes, upon reflection, nonessential. Not so with government. Most politicians see everything government does as essential and since they don't have to pay for anything with their own money, they are reluctant to cut spending, which they believe helps extend their careers.

Before he ran up the debt more than any other president, Barack Obama criticized George W. Bush for increasing America's debt. While a senator from Illinois and during a debate about whether to raise the debt ceiling, Obama said, "The fact that we are here today to debate raising America's debt limit is a sign of leadership failure."

Debt rose by $3.5 trillion in Bush's first five years in office, partially the result of the terrorist attack of September 11, 2001 and the subsequent war in Afghanistan. During Obama's two terms, the debt increased by $8.9 trillion.

How credible is China's reported consideration of slowing or halting the purchase of U.S. treasuries? For one answer I turn to Ric Edelman, my financial adviser, whom Barron's has consistently ranked high among the nation's top 100 independent financial advisers.

Responding by email to a question about Chinese intentions, Edelman says, "I'm not sure I buy it -- either that the Chinese will pare down its U.S. debt holdings, or that doing so will cause Congress to rein in spending. On the former, what will the Chinese buy, if not Treasuries? It's not like there's a huge array of alternatives for them. On the latter, I don't think I need to elaborate."

One of the reasons empires and great nations have collapsed throughout history is burdensome debt. No individual can keep spending as if there is no tomorrow, so why would anyone think that a nation can continue deficit spending and still expect a tomorrow?

Companies that consistently spend more than they take in usually go bankrupt. Nations that consistently spend more than they take in and continue borrowing to keep the illusion of prosperity going usually just collapse.

There is always a day of reckoning for such irresponsible behavior. It is not a matter of if, but a matter of when.

Whether China actually slows or stops buying U.S. Treasuries, just the threat should awaken sober minds in Washington. Unfortunately, I fear Mr. Edelman is right in his skepticism and sober minds hardly exist in a capital that is drunk on spending.

China holds a little over a trillion in US Treasuries, out of about thirty trillion outstanding.

They have to have dollars (Treasuries) to settle trade transactions, and for other purposes.

I think that they just don’t have the money to build up their Treasury holdings anymore. That was the announcement - they are done re-accumulating up to their target, and won’t be stockpiling a higher balance.

They burnt through a lot of their foreign reserves trying to support their currency and stock markets, and then struggled to put a couple of hundred billion back into their Treasury account over last year. Now they have all they budget for a foreign reserve savings buffer. They were net sellers when their markets and currency were teetering, they were net buyers last year, and now they plan to be net neutral.

Not only do they not hold enough Treasuries to make a major effect on the US Government or economy, they can’t afford to use that much of their foreign reserves for anything, without threatening their own economy more. They have problems of their own.

I am pretty sure that Trump knows very well how the unfair trade with China works (he states it well, and has for a long time).

He has some of the best (Wilbur Ross) and most notoriously opposed to the communist Chinese (Peter Navarro) in charge of trade policy.

Everything that I have seen indicates to me that the Trump Administration has a broad strategy to turn things around with China on trade - at that they are going for the roots of the problem, not just the low-hanging fruit.

Also, China is not very solid economically. They achieve some good top-line economic numbers, only through the use of some very corrosive cheats.

Their banking system is a house of cards, rife with fraud, with no real assets behind much of the loans they show on their books.

Their growth boomed with a bunch of foreign investment, but now the tide has turned - capital (including native Chinese with their own money) has been trying hard to get of China for the last few years. The Government there has had to impose increasingly strict capital controls (restrictions) on outflows, and has had to go to great lengths to shore up their currency (as so many people and businesses tried to sell their Yuan to buy things overseas in Dollars or Pounds). Managing (manipulating) the exchange rate of their currency is the biggest thing that drives their purchase or sale of US Treasuries.

Their growth is dis-proportionally due to new investment (rather than consumption), but much of that investment spending has been Government money mal-invested into boondoggles that will never pay back their loans, like their so-called “zombie cities” that stand unoccupied and rotting away. They have been wasting a lot of their money for a long time, to buy just a short term boost and the political benefit from that.

Their population wave (which had been supporting their growth) has now crested, as a result of their long-running one child policy. Now their demography will be a drag on economic growth, for about the next twenty years.

Their economy is hugely dependent on import of raw materials and energy, and the export of manufactured goods. Giant vulnerabilities all around in percentage terms. They are hopelessly outmatched by the USA in a potential trade war - dramatically more so than they would be in a shooting war (where they are also outmatched, except for a land war in their backyard).

The Chinese economy is walking on eggshells, far overdue for a serious correction, whereas the US economy is just taking the shackles off a bunch of pent-up potential growth.

Ever since the ascension of Xi Jinping as head honcho, the party has been engaged in a theft spree involving the personal fortunes of some of the country's wealthiest tycoons. This has been labeled an anti-corruption drive, when all those individuals did was bribe officials to buy political protection, much as Microsoft and Google lobby local and Federal officials. The amounts in China are larger, because the government officials are more powerful and less subject to checks and balances. The net effect of this large scale confiscation is that the wealthy are trying spirit their wealth out of the country, away from the sticky fingers of government officials. Li Ka-shing, the Hong Kong tycoon who is reputedly one of the richest men in Asia, led the way by exiting significant portions of his investments in China:

He isn’t without his controversies or criticisms, as is the case with many wildly successful men. For example, he’s been criticized for reducing his investments in China and increasing them in Europe.
While declining to respond for some time, Li finally released a statement reminding his detractors that he still had a large retail presence in China, and that some of his reluctance to invest more in China stemmed from his feeling that the nation might be headed back into a “cultural revolution way of thinking.”

Given Li's reputation as a savvy investor and reader of the political tea leaves, it's not particularly surprising that many Chinese tycoons are getting the heck out of Dodge while they can. While a good chunk of their businesses rely on China's domestic market, many are salting away as much of their net worth abroad as possible, which is why the Chinese government has slammed the brakes on their investments abroad.

The search for other ways to move money out of China may have had side effects. For instance, part of the bitcoin craze could be a bona fide mania. However, a good chunk of it may be related to the Chinese trying to bypass the party's capital controls. The beauty of bitcoin and other virtual currencies is the way money movements are transacted in secret. The rise of alternatives to bitcoin is probably also a combo of mania and diversification for Chinese flight capital. A DEA report has fingered Bitcoin as an avenue for bypassing Chinese capital controls:

Bitcoin is increasingly used by Over-the- Counter (OTC) Bitcoin brokers who conduct very high-risk Bitcoin trading consistent with Chinese capital flight and money laundering. These high-risk OTC Bitcoin brokers likely use foreign Bitcoin wallet-hosting services and exchanges that do not properly conduct “know your customer” or anti-money laundering monitoring on Bitcoin purchases. OTC Bitcoin brokers primarily attract two types of clients: those who want to use Bitcoin to move their money out of China and those who want to convert large quantities of cash into Bitcoin. CUBS money brokers sell Bitcoin to drug traffickers for cash earned from drug sales in the United States, Australia, and Europe. This drug cash is then sold to Chinese nationals in exchange for Bitcoin the Chinese nationals use to transfer the value of their assets outside of China. The increasing use of OTC Bitcoin brokers, who are capable of transferring millions of dollars in Bitcoin across international borders, as part of a capital flight scheme is expected to continue to intertwine criminal money laundering networks with capital flight.

Now, VPN's are increasingly an endangered species in China, driven possibly less by the fear of ordinary Chinese being corrupted by foreign ideas than by capital flight via virtual currency trading. However, it would not surprise me if there are chinks in the VPN armor, that some of the more cynical enforcers of the Great Firewall have themselves been bribed to allow exceptions for people facilitating capital flight. Given the amounts involved, even a tiny slice would keep the suborned enforcers in clover.

“...(companies in China) buy political protection, much as Microsoft and Google lobby local and Federal officials. The amounts in China are larger, because the government officials are more powerful and less subject to checks and balances.”

This also indicates that those remaining large investors and companies (like Ali Baba), are likely even more co-opted in service to the Party and the Intelligence Services than before (if there ever was any option), when the come here to buy key technologies or critical assets.

American IT, AI and genetic technologies are being procured to implement even more monstrous organs of repression on the Chinese people, by the communist regime. Maybe that is an area for a trade barrier on technology, for humanitarian reasons.

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