I had a discussion with a friend of mine on the US trade deficit and on an article published by Buffett in 2004 on Thriftville vs Squanderville. I am posting this on my blog to keep track of these kind of discussions.
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Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.
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If thriftville citizens don't believe in the squanderbonds, the squanderville residents know more about their bonds and so will not give squanderbucks for the squanderbonds. They already know those squanderbonds are not worth much. ok, you may say that the squanderville govt will give thriftville squanderbucks in redemption of the squanderbonds. Those squanderbucks won't buy much property of squanderville either - as they try to buy property, thriftville citizens will find that the property costs in thriftville shoots sky high.
Coming back to reality, china can't do much with the $2 trillion of US bonds - if they try to buy land assets in the US, the huge liquidity will shoot up property prices here that they would only be able to buy say 10% of what they thought they could buy. A foreign country never gets to own another country by stealth - they own it by attacking it militarily (or meddling around using military powers). If china doesn't believe in the US bonds, nobody is preventing them from buying up private businesses here (if they can get thru all the regulatory loopholes). It will be actually good that they did that instead of buying the US bonds. but buying private businesses also carries with the responsibility of managing it - it won't be a passive investment any more. are they up for it? and the chinese assets could be seized by a class action lawsuit by chinese US citizens who have suffered human rights abuse back home.
and you have a hangup with default. defaults and bankruptcies happen all the time in the US - that is a good way of eliminating the weaklings and having more efficient firms survive. Whenever a bank gives a loan to you, your credit score is used to set the interest rate. The higher interest rates for higher risk customers is done on the assumption that a certain percentage of customers are going to default. It is accepted part of the system. Venture capitalists do fund people who have failed more than a few times starting businesses. You give credit to entities after looking at their business case and if the entity fails, it doesn't mean all the employees of the firm will become slaves to the creditor. The creditor is looking for yield and there is always risk in losing it all. The different creditors have different priorities in collecting the liquidated assets, based on how the debt was secured.
Trade deficits are created not by the action of just one trading party but by both. If china had allowed free floating of its currency, its currency would have kept rising to eliminate the trade deficit. They created their dollar reserve by deciding to keep the yuan pegged to the dollar at a low level. They released more yuans into their economy thru that process and high inflation is an effect of that. The chinese govt. is seeing the high inflation and not able to decide what to do. Without foreign exchange manipulation, you don't get huge trade deficits. There is no trade deficit between Massachussets and Missouri - Mass residents won't sell to Missouri residents without getting properly compensated for it.
Every country in this world wants to be a net exporter and that is a mathematical impossibility. All the asian economies want to save 30% of their salaries and that is not sustainable - you can only do that if you remain a perpetual exporter. Their savings will get spent by the consuming nations like the US. and there is no point in saving money beyond a certain emergency need. At an individual level, you are exposed to job losses but at the system level, the job losses won't be more than say 20% (which was at the height of the depression in the 30s). That is why countries create safety nets which are like insurance systems to increase economic acitivity. If you are a self-contained nation (net zero export-import), any savings will get wiped by slowing down of the economy to a level where the average savings comes down to zero. Money is just a medium to trade and it has no value by itself other than what is set in the market in terms of its tradability.
I do consider the govt deficit to be a serious problem compared to the trade deficit. China is abetting the US govt to run these deficits by buying the govt. bonds. The govt deficit can not run at this current pace for long. increase in taxes, decrease in govt spending - something has to happen and usually this country does take some steps or the market forces it to. I am quoting Buffet again below:
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I will close by reminding you again that I cried wolf once before. In general, the batting average of doomsayers in the U.S. is terrible. Our country has consistently made fools of those who were skeptical about either our economic potential or our resiliency. Many pessimistic seers simply underestimated the dynamism that has allowed us to overcome problems that once seemed ominous. We still have a truly remarkable country and economy.
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The US is still an amazing country compared to the rest of the world. In fact, Buffet lost money on his currency bets as the US currency actually appreciated after Jan 2004. During last year's crisis, the whole world flocked to the US dollar. and Buffet said that he is making a bet on the US economy when he bought CSX a few months back.
1 comment:
I commented to my friend on a followup to the discussion.
The hole I refer to is the too simplistic analysis of how china would take over the US by stealth. This was the same argument that was given about the Japanese in the 70s and 80s - nothing like that happened, and the japanese lost a lot of money in the few assets that they tried to own in the US. The chinese borrowings are denominated in US dollars and the borrowings are not secured by identifiable assets. It is not like if we default, they automatically own all the US assets. If china wants to buy US assets, they have to compete like anybody else in the world to buy them. They tried to diversify away from US bonds and bought into Blackrock investments - lost loads of money on that investment. Once you buy an asset, you have to actively manage it to keep it productive or somebody else will take it over. It is not easy to own an asset and keep it productive.
Most of the money Buffet has made has been on his interests in the US - he hasn't made a lot of money by shorting the US. I don't know exactly how much Buffet made in his foreign currency transaction but I suppose it is certainly not his top return producing positions.
The modern economy can only run thru consumption - be it goods or services. You may not want to buy a consumer good but you still have to buy a service (could be a yoga class and the yoga master could be buying consumer goods) to fully contribute in the economy. The goal is to keep people employed in a non-slavery environment (where you are not bonded to an employer for life) - different people will earn different amounts of so-called money depending on their skill sets and the suppy-demand of those skill sets. We have a lot more people in this world compared to the amount of people required to say make the basic items for survival - so for fuller employment, we have to keep exchanging goods and services that is beyond basic survival. easier to sell goods to the masses as it is more tangible in nature but then entertainment services sell in a big way too. Laws and regulations should try to keep some sense of fairness in the exchange as a small number of people will try to corner the system using loopholes. Money is a good way to make value comparisons between buying one good or services vs the other but shouldn't be used at the lowest level to make decisions on whether a human being should live or die (by not providing food, basic health service) - that is why the govts should have safety nets in place to protect from making basic survival decisions using money (foodstamps, Medicaid are all geared towards this).
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