Finale: Keep Your Balance

Part 4

We keep reading that as a big lender to the U.S., China has this immense power.  Well, how does it use that power?  Any banker knows this game.  If you have loaned a lot of money to someone, you can ask for it back, but that may not be in your best interest.  Why?  First, you have to find someone else to borrow it with an equivalent risk/return profile, and second, you might not get it back at all.

The Cowboy would argue that this power is illusory.  Where the hell is China going to put all of that money?  Now more than ever, investors are concerned about risk.  Where’s the safest place for your money?  U.S. Treasuries.

Let’s say you did try to dump all of that debt.  Well, remember that these investments are tradeable things with prices attached, just like gold coins or TV sets.  If you start to sell a bunch, the price drops and you get less than you would if you had not sold so many at once.  What happens to the U.S.?  The cost of capital rises, including interest rates.  What happens then?  American consumers buy less.  You, the Chinese policymaker, have just become responsible for the loss of more jobs back home, meaning more angry young people and less stability.

The Chinese would love to have more international power, to replace the U.S. as the single global superpower, but not if those who control the reins today are not the ones in charge.  For the time being, with a poor and restless population, a status quo in the international economic system and steady growth at home are the keys to allaying the fears that keep you up at night.

Further, amidst all of the fiscal stimulus coming from countries around the world to address the current crisis, and the massive increase in government debt that goes along with that, there are many concerns being voiced about the consequences of all of this debt.  The Cowboy shares these concerns, but as Reagan-era supply-siders and W-era defense hawks argued, the risks of an increase in sovereign U.S. indebtedness are murky at best, especially when those debt increases are incurred as a result of policies that have stimulative effects.  Lastly, and most curiously, the policy prescription that a central banker would use to address the excess of debt once there is an economic rebound, possibly coupled with inflation,  is to increase interest rates in order to discourage borrowing.  This is the same thing that would occur of the Chinese started to sell their U.S. debt.

The Cowboy won’t dismiss all of the fears of the West, or the U.S. specifically.  These are complex, interwoven issues that cannot be accurately predicted or modeled.  As Nassim Taleb himself might say, one cannot predict the black swan.  The trail we just followed, despite its twists and turns, is at its core, a simplified analysis.

But now, dear reader, before you repeat a sound-bite decrying this or that or advocating one policy over another, think about the trail a bit before nodding your head or raising your voice.  Simplicity is fine, but one has to understand that there is complexity too.  And as for following the trail, it’s easier to do than you might think.  You can keep it simple but still get a sense of  the complexity.  And that’s not a bad outcome.

Macroeconomic policy prescriptions are balancing acts.  If you pull on the reins too far one way or the other, treat your horse too gently or too firmly, you won’t achieve the ideal harmony between rider and horse that an experienced Cowboy desires and expects.  Despite all of our efforts to make it otherwise, it’s still an art.

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Published in: on April 8, 2009 at 20:59  Comments Off on Finale: Keep Your Balance  
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