NationStates Jolt Archive

What happens to the US economy when China dumps the dollar (http://www.washingtonpost.com/wp-dyn/content/article/2006/01/09/AR2006010901042_pf.html) and by extension, stops funding our deficit spending?

SHANGHAI, Jan. 9 -- China has resolved to shift some of its foreign exchange reserves -- now in excess of $800 billion -- away from the U.S. dollar and into other world currencies in a move likely to push down the value of the greenback, a high-level state economist who advises the nation's economic policymakers said in an interview Monday.

As China's manufacturing industries flood the world with cheap goods, the Chinese central bank has invested roughly three-fourths of its growing foreign currency reserves in U.S. Treasury bills and other dollar-denominated assets. The new policy reflects China's fears that too much of its savings is tied up in the dollar, a currency widely expected to drop in value as the U.S. trade and fiscal deficits climb.

China now boasts the world's second-largest cache of foreign exchange -- behind only Japan -- and is on pace to see its reserves climb past $1 trillion later this year. Even a slight diminishing of the dollar as a percentage of those holdings could exert significant pressure on the U.S. currency, many economists assert.

In recent years, the value of the dollar has been buoyed by major purchases of U.S. Treasury bills by Japan, China and oil-exporting countries -- a flow of capital that has kept interests rates relatively low in the United States and allowed Americans to keep spending even as debts mount. Some economists have long warned that if foreigners lose their appetite for American debt, the dollar would fall, interest rates would rise and the housing boom could burst, sending real estate prices lower.

Now what I don't know about macroeconomics is practically all of it, but this doesn't sound good to me, especially since we've spent the last thirty years getting rid of our manufacturing base, which would be helped by a weakened dollar. Are we in for really rough times if China divests itself and stops buying bonds?

I am in the mortgage business and whenever there is a sell off of US treasuries - the treasury yield moves higher. As treasury yields move higher, so do mortgage rates. As mortgage rates rise, home values usually decline. A massive sell-off of US Treasuries by China would certainly have a negative impact on mortgage rates and I would bet that home values would soon follow suit. Be careful with those equity lines, adjustible rate mortgages and 100% financing loans - you could be in trouble soon. Many people will lose their homes when this starts to happen.

The way to look at this is that the US economy is really a worldwide economy. The US money supply is not limited to the borders of the US. So when China dumps their dollars, they will be snapped up at a lower price by less stable economies and then loaned out to businesses. The dollar will be lower, so US exports will be cheaper. Sure $800 Billion is a lot of money but the US GNP is over $10 TRILLION so it's really a drop in the bucket. And the Chinese aren't going to dump it all at once because they will be getting less in return. So it's in the chicoms best interest to realese a few billion and wait for the market to bring the price up and then dump a little more.

That's the way I see it but it's been 15 years since I took Macro. I'm probably wrong.

EDIT: Also, the US Treasury will buy back currency if the value drops too low to avoid deflation. Deflation isn't the exact opposite of inflation in that it is not a good thing either (look at what happened to Japan in the 90's-they went into a deflationary cycle.)
What happens with deflation is that companies are paying workers to produce with the price determined as a cost of production+profit based upon demand for that product. Then it turns out that they were paying the people too much, so the price of the product is too high. They have to cut the price (because warehouses are full and there are more being produced daily) and POOF there goes the profit and maybe a loss is taken because the cost of production was at a higher level too. That sets off a chain of layoffs then unemployment brings a whole other set of problems.

we all die and the nation falles in to a massive depression

The US dollar has been under pressure to drop for a while now and it still hasn't. Let's sit back and see if this does anything. Anyway, China isn't going to do anything too crazy with its reserves -- especially since if China ended up being blamed for a drop in the dollar it would greatly add to the protectionist whisperings already going on in the US, which is just as bad for China as it is for anyone. For the sake of politics alone, China would never intentionally screw with the dollar. It's better for everyone involved if the dollar makes a slow glide into normalcy instead of a sharp drop.

If i'm not mistaken, china's debt-buying is the mechanism that pegs the yuan to the dollar, I think its in china's interests to gut the dollar only so long as the yuan stays pegged to it, which might limit the ammount they were able to force it down.

The US dollar has been under pressure to drop for a while now and it still hasn't. Let's sit back and see if this does anything. Anyway, China isn't going to do anything too crazy with its reserves -- especially since if China ended up being blamed for a drop in the dollar it would greatly add to the protectionist whisperings already going on in the US, which is just as bad for China as it is for anyone. For the sake of politics alone, China would never intentionally screw with the dollar. It's better for everyone involved if the dollar makes a slow glide into normalcy instead of a sharp drop.

isn't China sort of being pressured to "normalize" their currency... like they're currently being called "cheaters" in international trade?

I am in the mortgage business and whenever there is a sell off of US treasuries - the treasury yield moves higher. As treasury yields move higher, so do mortgage rates. As mortgage rates rise, home values usually decline. A massive sell-off of US Treasuries by China would certainly have a negative impact on mortgage rates and I would bet that home values would soon follow suit. Be careful with those equity lines, adjustible rate mortgages and 100% financing loans - you could be in trouble soon. Many people will lose their homes when this starts to happen.That's the big scenario I keep reading about, which is worrying because something like 40% of the jobs that have been created in the last four years have been construction or financial services jobs, and if that growth stagnates, the economy as a whole will feel it. I wouldn't feel so nervous about this if the US still had a significant manufacturing base, because a weak dollar would be beneficial in the short term. But are any manufacturing companies going to be come back to the US if they perceive this to be a temporary situation? How bad is it going to have to be for them to reinvest significant money in manufacturing in the US, especially if they're assuming that in twenty years or so, they'll be shipping jobs back overseas?

isn't China sort of being pressured to "normalize" their currency... like they're currently being called "cheaters" in international trade?
For ages. I believe its artificially pinned below the dollar, so however low it falls, China's goods are still cheaper than saltwater. However, the exact dealings of it, I'm not sure of. I've never investigated it fully. Its the Chinese government's drive to modernize and whatnot.

China has its own problems though. Especially since they have internet cops that can censor things, for example, on this forum if it was in China. The Chinese people are also angry about the government buldozing their homes for roads, shopping centers, and other empty buildings. And the income difference between rural and urban is estimated to be the higest in the world.

If the dollar crumbles, and US purchases decline along with our deficit, someone else is going to have to pick up the purchasing and defict slack or we'll be looking at some kind of global depression, however, we don't know at what magnitude. Could be a dent, it could be somewhat worse.

- Arm Chair Economist, Mariehamn

The way to look at this is that the US economy is really a worldwide economy. The US money supply is not limited to the borders of the US. So when China dumps their dollars, they will be snapped up at a lower price by less stable economies and then loaned out to businesses. The dollar will be lower, so US exports will be cheaper. Sure $800 Billion is a lot of money but the US GNP is over $10 TRILLION so it's really a drop in the bucket. And the Chinese aren't going to dump it all at once because they will be getting less in return. So it's in the chicoms best interest to realese a few billion and wait for the market to bring the price up and then dump a little more. Okay, if China dumps dollars, who's going to buy them, and at what interest rate for the US? Part of the reason we've been able to keep spending so recklessly, as I understand it, is that China has bought dollars at low interest rates. Is anyone else going to do that, or will we have to raise interest rates as a result? And do we have the manufacturing base left to have a real effect on our trade deficit?

That's the way I see it but it's been 15 years since I took Macro. I'm probably wrong.

EDIT: Also, the US Treasury will buy back currency if the value drops too low to avoid deflation. Deflation isn't the exact opposite of inflation in that it is not a good thing either (look at what happened to Japan in the 90's-they went into a deflationary cycle.)
What happens with deflation is that companies are paying workers to produce with the price determined as a cost of production+profit based upon demand for that product. Then it turns out that they were paying the people too much, so the price of the product is too high. They have to cut the price (because warehouses are full and there are more being produced daily) and POOF there goes the profit and maybe a loss is taken because the cost of production was at a higher level too. That sets off a chain of layoffs then unemployment brings a whole other set of problems.
How will the US Treasury buy back currency? Like I said, what I don't know is just about everything--are you talking about tightening the money supply? wouldn't interest rates rise as a result and make capital investment more expensive?

Thanks Nazz. You've given me a day project.

Thanks Nazz. You've given me a day project.
Glad I could help. :D

This is what I'd like to call a very foolhardy strategic mistake for the PRC, for if they slowly and responsibly decrease their holdings of American dollars, that means the chief economic anvil they continue to hold over the US, the threat of a sudden dollar dump is seen as the PRC's chief strategic advantage, espescially if a spat develops over Taiwan. And if the slowly decrease their holdings then it won't be anywhere near as bad. Sure, it won't be good, but it could be worse.

We couldn't expect them to hold on to dollars forever, could we?

To address the main question of this thread: what I don't know about economics could fill many volumes. But a lot of people who know better have been saying that, while China could indeed do this kind of thing, it would not be in their best interests either, and they understand that.

And, secondly...

That's the big scenario I keep reading about, which is worrying because something like 40% of the jobs that have been created in the last four years have been construction or financial services jobs, and if that growth stagnates, the economy as a whole will feel it. I wouldn't feel so nervous about this if the US still had a significant manufacturing base, because a weak dollar would be beneficial in the short term. But are any manufacturing companies going to be come back to the US if they perceive this to be a temporary situation? How bad is it going to have to be for them to reinvest significant money in manufacturing in the US, especially if they're assuming that in twenty years or so, they'll be shipping jobs back overseas?

I think moving so much of our manufacturing base overseas and relying so much on imports was a big mistake in the first place. Not only has it eroded the foundations of our economy, but it has had a very detrimental effect on working-class people who are now condemned to unemployment or crappy jobs in the service industry where the pay is a joke and there is no hope of advancement. In the short term, moving manufacturing overseas and relying on imports is cheaper, but in the big-picture, long-term sense it is tempting a terrible disaster. But most people don't understand that.

Just another good reason to join the Military. No one ever gets laid off, and they give you a 3% pay raise each year. Plus the benifits can't be beat, and everything on base is tax free.

I've never not cared about the economy so much in my life, in terms of how it will affect me. :D

(note, I still care how it will affect others, but the elephants off MY chest!)

Okay, if China dumps dollars, who's going to buy them, and at what interest rate for the US?

China can dump dollars by selling their t-bills but they don't necessarily have to. They can wait for their short & long term notes to come due and simply reinvest the funds elsewhere.

This is what I have come up with so far:
Okay, if China dumps dollars, who's going to buy them, and at what interest rate for the US? Part of the reason we've been able to keep spending so recklessly, as I understand it, is that China has bought dollars at low interest rates. Is anyone else going to do that, or will we have to raise interest rates as a result? And do we have the manufacturing base left to have a real effect on our trade deficit? The US economy is the bedrock for the rest of the world and countries with less stable economies shore up their currency by purchasing US bonds because they know that the US will pay up if/when the bonds are cashed in (IOTW, we have a great credit rating). Because of that these bonds are only going to fall so far before they become a bargain at which point they will be bought (basic supply and demand market mechanics). It's not like we are Bolivia or Haiti, there will be buyers.
At the same time, the Fed may or may not decide to raise the prime rate (the Fed is the bank all of the other banks get their money from and they loan it to them at the prime rate, you and I have to borrow the money at a still higher rate.) If they increase the yield of the bond (raise the prime) that makes the bonds more attractive to buyers.
So raising interest rates isn't necessarily a bad thing as long as there are buyers. The reason people buy stocks or bonds has to do with return on investment. The reason the stock market is doing better than the bond market is that investors have calculated that stocks return more ROI than bonds. Stocks and bonds are inverse in relation to each other. Right now, the stock market is a better investment because bond prices don't offer as much in ROI. If there is a higher rate of inflation the bond market will have a better ROI because the Fed will have to set the prime rate higher to account for inflation. Meanwhile, the dollar of stock I buy today is being eroded by inflation so the stock market (which is heavily influenced by consumption level) becomes riskier.How will the US Treasury buy back currency? Like I said, what I don't know is just about everything--are you talking about tightening the money supply? wouldn't interest rates rise as a result and make capital investment more expensive.

Buy back is misleading. They actually have several different methods. One way is pretty straight forward-when you deposit the actual money in the bank, the bank sends it to the Treasury and they burn it. Less money supply=increase in value of the money still out there. Another way is to stop offering bonds to sell or to take the unsold bonds off the market.
Then there is a thing called 'velocity' (the amount of times $1 is used to purchase something=about 7x last I remember).
But here's the thing-the banks help create wealth as long as they continue to be able to loan money. So lets say I take out a loan from Bank X. I use that money to start a business and to do that I have to disburse my loan money. Some of the people take the money I gave them and then deposit it in Bank X, (the rest, at some point will eventually wind up in a bank but I'm shortening the cycle as an example).
Bank X then loans the money out again at an interest rate, and the same thing happens again. They've just loaned the same dollar twice and are getting some % in interest off of both loans. The money paid in interest, has just been created and added to the money supply.

It depends, really. China has no interest in seeing the dollar tank, since they stand to lose the most from it along with other nations stocked up on our treasuries. They might diversify a little, but our bonds are simply too good for them to get rid of. No other developed nation offers as good returns as the US does.

At the same time you have to remember that the US has the best ROI relative to the safety of its bonds, which are the safest in the world; there would be other buyers for them almost undoubtedly. There would probably be upward pressure on interest rates and the dollar would weaken, but $800 billion isn't an overwhelming amount of money to finance and it would never be reduced all at once.

China's diversifying its holding probably because of the revaluation of their currency, which reduces the advantage of holding dollars in their reserves.
Plus, a freely traded yuan would enable our manufacturers to better compete provided we don't enact tariffs or punitive taxes (like that dumbass in Michigan wanted) which caused the decline in manufacturing in the first place.

I think moving so much of our manufacturing base overseas and relying so much on imports was a big mistake in the first place. Not only has it eroded the foundations of our economy, but it has had a very detrimental effect on working-class people who are now condemned to unemployment or crappy jobs in the service industry where the pay is a joke and there is no hope of advancement. In the short term, moving manufacturing overseas and relying on imports is cheaper, but in the big-picture, long-term sense it is tempting a terrible disaster. But most people don't understand that.

No, what is a disaster is what we did to cause this. For decades, US industry was ridiculously protected by the government, to the extent that GM and Ford literally monopolized the car market. They turned out junk products with poor mileage and high costs/low productivity, but when the Japanese started to compete, they couldn't do a thing about it and sank in to a decline that continues to this day.

The government was pressured by unions and corporate executives to protect the industries rather than force them to compete, with the result being that they eventually fell so far behind in terms of efficency and costs that they were forced out of business. Ironically, it's the Japanese automakers that outsource their plants to the US and are booming while GM and Ford build them in China and are doing terrible. American workers are some of the best, but they have been screwed by a government that gave in to the union leaders and executives and led to te decline in manufacturing.

This spread to many other industries, and so our economy was being propped up by tariffs...and complacency led to its downfall. Generally, if GM had been forced to break up in the 1950's and spin off its auto suppliers it is feasible that at least 75% of the American auto market would have been made by American automakers...this is the damage of protectionism in action.

Tarriffs and economic nationalism ruined this country's manufacturing sector, and they'll do it again if we try to impose them.

That's the big scenario I keep reading about, which is worrying because something like 40% of the jobs that have been created in the last four years have been construction or financial services jobs, and if that growth stagnates, the economy as a whole will feel it. I wouldn't feel so nervous about this if the US still had a significant manufacturing base, because a weak dollar would be beneficial in the short term. But are any manufacturing companies going to be come back to the US if they perceive this to be a temporary situation? How bad is it going to have to be for them to reinvest significant money in manufacturing in the US, especially if they're assuming that in twenty years or so, they'll be shipping jobs back overseas?

Well, the thing with manufacturing is that the industry is shifting. The decline in manufacturing isn't "real" in the sense that most jobs are disappearing, but rather they are becoming part-time to reduce or eliminate benefit costs. We have the manufacturing base, but it's not as large in terms of employment as it once was.

You are correct in saying that the majority of jobs are in construction or finance; they are also in professional/business services. Now this isn't bad; these sectors pay very well and are often better and more opportunity than manufacturing in terms of wages. Finance and business are also pretty safe, but construction losses could be heavy and that burden would hit the lower classes very hard. Ultimately, this growth is great for the middle and upper classes but screws the lower class.


Also, finance and business require more edcuation than most manufacturing, which can be a problem for the poor and undereducated.

Ironically, it's the Japanese automakers that outsource their plants to the US and are booming while GM and Ford build them in China and are doing terrible.

Wasn't that move more about the cost of shipping the final product here and the tarrifs involved....

No, what is a disaster is what we did to cause this. For decades, US industry was ridiculously protected by the government, to the extent that GM and Ford literally monopolized the car market. They turned out junk products with poor mileage and high costs/low productivity, but when the Japanese started to compete, they couldn't do a thing about it and sank in to a decline that continues to this day.


You aren't very familiar with the post-WWII Japanese economic recovery, are you? The US industry didn't monopolize the market because the government kept Japanese autos out of the market; it was because the Japanese kept Japanese autos out of the market. In the 50's, they did so primarily because Japan's infrastructure needed every transportation device available, so all auto production was assigned by the government to domestic use. In the 60's, they did so because they knew that they had an inferior product whose only redeeming quality was that American cars (although safer and made of superior quality) were nevertheless gas hogs because they were lumbering, completely steel leviathans. They only allowed companies like Toyota and Honda to export when they percieved a competitive advantage had opened up in the late 70's with the oil embargo. At the same time, Japan was heavily tariffing American goods to bulk up its domestic industry, a practice which effectively allowed Japan to flood the American market with cheap and flimsy but fuel-efficient vehicles while America could not even compete in Japanese markets.

Seriously, dude, not every problem can be traced back to American unions and protectionism. In point of fact, it was Japanese protectionism that allowed them their competitve advantage over American automanufacturers in the first place.

You aren't very familiar with the post-WWII Japanese economic recovery, are you? The US industry didn't monopolize the market because the government kept Japanese autos out of the market; it was because the Japanese kept Japanese autos out of the market. In the 50's, they did so primarily because Japan's infrastructure needed every transportation device available, so all auto production was assigned by the government to domestic use. In the 60's, they did so because they knew that they had an inferior product whose only redeeming quality was that American cars (although safer and made of superior quality) were nevertheless gas hogs because they were lumbering, completely steel leviathans. They only allowed companies like Toyota and Honda to export when they percieved a competitive advantage had opened up in the late 70's with the oil embargo. At the same time, Japan was heavily tariffing American goods to bulk up its domestic industry, a practice which effectively allowed Japan to flood the American market with cheap and flimsy but fuel-efficient vehicles while America could not even compete in Japanese markets.

Gm's dominance dates back farther than the 1950's, but the 1950's marked the peak of their power. They were brought before Congress even to account for their dominance, and the government did nothing but turn a blind eye to it. That eventually led to the decline in quality during the 1960's and 1970's, and the problems after that stemmed from these quality issues and their horrible gas economy.

American cars' quality plunged during the 1960's and 1970's due to lack of competition until the oil embargo hit and they were stuck with inefficent and poorly made cars, and then the Japanese entered the market along with Germany, and they put American automakers on the defensive because the American companies had lost their competitiveness in their highly protected market.

Seriously, dude, not every problem can be traced back to American unions and protectionism. In point of fact, it was Japanese protectionism that allowed them their competitve advantage over American automanufacturers in the first place.

Not to American protectionism, but protectionism in general. Japanese automakers succeeded because they invested far more in R&D and product design than American automakers did, and perfected a far more efficent and inexpensive system of manufacturing than we had...the tarrifs came back to bite them in the 1980's.

Wasn't that move more about the cost of shipping the final product here and the tarrifs involved....

Yes and no. It's cheaper to make cars in the US than Japan; the laws are less complicated as are the taxes and the cost of the land itself. Also, American workers are well qualified and that minimizes costs of training. Overall, American workers can be given excellent benefits and pay and are still able to produce cars for Japanese automakers more efficently than any other companies.

Wasn't that move more about the cost of shipping the final product here and the tarrifs involved....

I suspect not, in relation to the shipping part anyway. Since Malcolm McClean invented container-shipping, the cost of shipping goods around the world has plummeted. That's why you can get cheap nastly plastic bits of rubbish made in Taiwan and sold in Europe and the US - cheaper cost base overseas (esp in China - all that cheap labour y'see) and a very low transport cost owing to container shipping. The combination makes it all profitable.

Couldn't comment on tariffs tho' - know next to nothing about them.

Back to the original point.

Even if China just stops buying US currency; it may be enough to stop propping up the US currency and cause the US dollar to collapse.

Secondly, the idea of a big selloff has been dismissed to easily. With many Asian countries holding too much US currency and bonds, it would be very tempting to sell your currency first; before anyone realises that there is an oversupply and leave your neighbours with valueless currency. A rush sell may be the best way to get a return on your holdings; selling much of your currency at the higher prices, rather than selling it at a trickle rate for less than less.

Obviously the increased selling (or just reduced buying) of US currency will lower US dollar.

But what effect would a collapse of the US dollar have? I accept that if it was a singular shock; that it would initially worsen the US CAD before it got better.

However a sharp drop in the dollar, would cause inflation and adoption of contractionary monetary policy, increasing interest rates. This would partially offset the drop of the dollar and its affect on the US CAD. Furthermore economic activity would decrease and unemployment increase. This may further reduce the US CAD.

However I doubt the effect would be massive unless it damages people's confidence badly or the Federal Reserve fails to react properly. The effect on the US CAD is questionable, but in the long run it would probably improve.

Yes and no. It's cheaper to make cars in the US than Japan; the laws are less complicated as are the taxes and the cost of the land itself. Also, American workers are well qualified and that minimizes costs of training. Overall, American workers can be given excellent benefits and pay and are still able to produce cars for Japanese automakers more efficently than any other companies.
Except that that's becoming less the case. There was the case last year of Toyota deciding to build a plant in Canada instead of Alabama, despite similar tax break offers (Alabama's was slightly better), and even though their taxes would be marginally higher. They cited two main reasons. One was health care costs, but the other reason had to do with the educational level of the workers--they actually cited the poor educational performance of the average worker in Alabama as a major factor.

I've never heard "poorly educated" and "Alabama" in the same sentence. Aren't they considered the mecca of creationism?

If they do it slowly enough, it may serve to let some of the air out of the severely over-inflated American economy, shrinking it to levels where it makes sense based on its actual productivity, and where there's time (and incentive) for America to rebuild it's manufacturing base to level things off nicely. Of course, don't think this won't be painful. Any economic shrinkage means lost jobs and hungry people.

If they don't, the Euro becomes the world's economic superpower as the faith in (and hence value of) the dollar collapses. When every country knows that US dollars can be had cheaper if you wait til tomorrow than if you buy them today, the dollar crashes. When that happens, Americans can't buy imported products, and America relies far too heavily on imports of raw materials to keep what little base it has moving. This could open up a really bad cycle of American employment loss which then translates into fewer domestic purchases, which spins that economy down, and you get into a cycle of nothing is made because nobody has money to buy because nobody's making anything. Get into this cycle and there's a very serious danger of the dollar bottoming out completely, down to the level of the physical resources of the land and people.

Meanwhile, any countries that relied on American purchases to keep their own economies moving get hit with the ripple effect.

It wouldn't be pretty.