BUSINESS

Mon

W~~oQ~R

The U.S. Treasury And Dollar Will Weather The Storm, S&P Downgrade And Assailing China
Dee Woo, Beijing Royal School

I

Aug. 9, 2011,10:12
Recorrrrend

PM
~

1,168
III.,.

I

24
24 39

AAA

With little time to spare, Congress and President Obama passed legislation raising the debt ceiling on Aug. 2, 2011. The markets and sovereign states around the world now breathe a much-delayed and much-needed relief. Dee Woo Dee Woo is an economics teacher at the Beijing Royal School, a citizen economist, and a citizen diplomacy
Errail

Nobody knows how to react to the mooted American default. The US has been the cornerstone of free market economies for decades. So the contagious fear, however stoked by the frenzy of media and political theatrics, is not unfounded. People are worried that the default will trigger a collapse of the US dollar and treasury Bills (T -bills) and then the collapse of the world economy. Nevertheless, their fears are over-stretched. The global by those building of dominance of the US dollar and T -bills is not underwritten This dominance is deeply entangled in the decades-long

activist.
Recent Posts
• WhyAWar Between China And Vietnam Is Inevitable

• Sino-Forest, Chinese Bureaucratic
Entrepreneurship And Forestry ... Rise • The Boom And Bust Of China's

politicians' scheming towards the moral high-ground of an election. one of the most profound global empires in the human history: The American Empire. First, sustaining the global dominance of the US dollar and treasure bills is the absolute prerequisite for sovereign states to subscribe to the US imperialistic issuance and alliance against many Geo-political debacles (see in the pie-chart below). According to a detective-like analysis on the cunning report from Budget of the United States Government,in 2009 military risks and economic and diplomatic

spending accounts for 54% of the total outlays of the federal funds."current billion), the military portion from other departments misleading and vast underestimate plus 80% of the interest on the debt. In 2010, $80 billion was allotted to the US intelligence agencies' worldwide operations. In 2011, $54.6 billion was requested for U.S. diplomacy and development

military" includes Dept. of Defense ($653

($150 billion), and an additional $162 billion to supplement the Budget's

of only $38 billion for the "war on terror." "Past military" represents veterans' benefits

efforts, after accounting for programs outside State and USAID, Board of Governors, and the The colossal stakes here are not just for

such as the Peace Corps, the Broadcasting Millennium Challenge Corporation.

the US's sake. It is also necessary for the US to effectively manage the threatening global volatility on military and economic levels for its diplomatic allies and trading partners. For example, In the South China Sea, Japan, Philippine, Vietnam and Taiwan are increasingly demanding the US to enhance the buffer between them and the more assertive China. In the middle east, Saudi Arabia, Israel and other allies have long been agitated by Iran's nuclear ambition and the regional instability imposed by Arab Spring. To elicit the US's cooperation on economic and diplomatic issues, Frenemy

such as China has always applied the trickery of accelerating

T -bills buying to show friendly gesture when the relationship

with the US turns sour. It is no coincidence the more screwed up the world, the higher the demand for the T -bills.\ Second, all the major economies' performances are heavily collateralized against the US deficit. Failure to finance that

deficit will render these economies' production over-capacity

so severe that the blow will be lethal. In 2010, the gap

between US imports from China and what it sold to the country rose to $273.1 bn , the largest trade imbalance the US has ever recorded with a single country. When all the math is done, without the US, China is running a trade deficit with the rest of the world (the red line). In the meantime, the US accounts for 15.4% of all Japanese exports and 9.7% of all Japanese imports. The US accounts for approximately 10% of all German exports and 10% of all German imports. That year the US trade deficit with the rest of 32.8% on the year before, the biggest annual percentage gain since 2000. No other nation came a trade surplus the world hit $497.8bn,up

close to the U.S. deficit in that year while the US major trading partners all posted strong export growth. By shouldering decisive chunk of the global imbalance, the US greatly helps many countries' economic recovery.(Japan's

was more than 2.5 times higher than the previous year at $82 billion. Germany had €140.3bn trade surplus. China's 2010 trade surplus hit $183.1 billion.) The trade war didn't beak out under such a grievous global imbalance, mainly because the US didn't initiate an all-out trade war against China. Or we will all live behind the iron curtains of tariff retaliation. If these trade surplus countries fail to prop up the T -bills, the dollar will collapse as well. That will send the value of their own currencies through the roof, which will derail their export-led economies and precipitate a serious cost-push inflation to squash the profit margin of their export industries.

CHINlA'S TIRADE SURPflUS DEFICIT
U&$ Billions, 12M moving average. Shading denotes periods of vuen revaluation.

30

-China', with with

Global Trade, Balance US R,est of World

15

11995

2000

2a05

20110 Ipa ca pita I.c om

Sourc e: B,Ioom be rg, 'Cata Ipa Ca pita I Advi sors

I cata

Third,The

liquidity and shock absorber of the global financial system are most heavily leveraged on the treasury bills. The The post-crisis capital

melt-down of T -bills will precipitate the collapse of many profitable arbitrage opportunities.

requirements for banks enhance the importance of money market. T -bills are the most marketable money market security and the most important collateral. The fire sale of T -bills will paralyze the repo market, drive up the sweeping borrowing costs, suck dry the liquidity and close up the spread in the carry trade. The ensuing panic will be contagious. financial institutions will fall, even including some gigantic sovereign funds Finally, there is no other sizable asset pool other than T -bills able to absorb the chunk of the $10 trillion worth foreignexchange reserves piled in trade surplus nations. At $9.3 trillion outstanding, the U.S. Treasury market is second in size to Japan's government bond market, whose $9.7 trillion makes it the world's biggest. While Japanese bonds are mainly (90%) sold to domestic investors, the US sells around half of its bond to outsiders. It's unrealistic to say to convert the foreign reserve to German bunds, British gilts, or even gold. Because these markets are puny compared to the mammoth portfolios hoarded by countries such as China and Japan. As long as the US stays as a global empire, shoulders much of the global imbalance, and export-oriented economies Many

refuse to alleviate the global imbalance and continue to swallow up gargantuan trade surplus, the US dollar and T -bills will

perch on the top of the world. Who said the whole world can't roll over as much as T -bills to entertain the American politicians' thirst for political theater and flirtation with a temporary default? It's not a sucker punch. Take it however it comes. No need to panic and ignore the rating agencies.See gobbling up t-bills through proxy agents all over the world. Once the market is weaned off the fear, everything will go back to normal. The world indeed needs to decouple its well being from the US deficit. But that won't happen in the next decade.Things will go terribly wrong if there is a sweeping house bet against T -bills. And then everyone will start guzzling T -bills again, just like S&P's downgrade never happened. The worst scenario is the Federal Reserve can initiate QE3 to save the day. S&P can't terminate the dollar's status as the world reserve currency. And guess where is everyone going to park the dollars from QE3? the chart below, there were countries doing rather well after losing triple A. Another good news is China is bluffing when it says it will reduce its t-bills holding. Under the radar, China is

ASJ( All O,dinorios

s&P TSX ComP>05ite
~,Iloo .

J.p.n@,olO-ywrbond

::~
J:.~OO First downgrad~d

l.5
...", •..""" ..", . 2'O'~""""""""""""""

4'6oo,~"".""" 4,400

1.5 .. "", ... ,, ... "" ..... ", ... ", .. .. '.'
First dowll'g:rad'-ed

1.0·....... "" ...."" ..."" ...."" .. 0.5

·Fir';Y~owiiii;;;'d';d··"". .
til N'lJovember 199:6

1,1M

r;···J;······ T~""'T~
I'll!"

in September

1.'96&

4,000

1~·r~····T;·....·I;'
1995

'nApriI19"·'

o IN ID

I,

IF

1'199

Please follow Money Game on Twitter and Facebook. Follow Dee Woo on Twitter.

Tags: S&P Ratings Downgrade, China Get Alerts for these to ies»

Click he re to download documentsyou need

BUSINESS [NSIDER

Share:

Short URL

I http://read.bi/ror9tz
Alerts

Twitter

Faeebook

Buzz

Digg

Stumble Upon

Reddit

Linkedln

Email

Embed

Newsletter

The Water Cooler
24 Comments Stefano on Aug 6, 9:16 AM said: Dee, great article, really!
Receive email updates on new comments!

o

o

Flag as Offensive

THE AMERICAN EMPIRE ... I strongly agree with this concept, and people should always remind how these Empires born, grow and, at a certain point ... DIE! History is full of sample of mighty empires that, sometimes SUDDENLY, collapsed: even if we are FAR from this point in the American example, I agree with you ... Anyway, I always suggest the GREATEST BOOK (IMHO, of course ... ) ever written on this subject: "The Peloponnesian Wars" (by the ancient historian THUCYDIDES): it should really be a MANDATORY LECTURE for all of the Members of US Senate and House ... I think they could find SEVERAL CONNECTIONS between their present situation and the old stories from ancient Greece ...

Reply

Dee Woo (URL) on Aug 6, 9:41 AMsaid:

2

o

@Stefano: Thanks, Stefano, especially for the book recommendation!About the debt ceiling, I have long been saying that the US Flagas Offensive won't default and the T-bills and the dollar will stay good, regardless what rating the US will be given.The idea of debt ceiling is ridiculous, because it's imaginary. It won't break a sweat for the US to raise money. It's so shame that the politicians care more about their careers than the fragile country.

Reply

km4 on Aug 9, 10:33 PM said: @Stefano: Dent worry read and see these .... On Perpetual ZIRP http://goo.gl/ly5dxThisactionisindefensibleoneconomicmerits.This for mixing politics with money. Dylan Ratigan, Mad as Hell: His Epic "Network" Moment http://bit.ly/pbOYG1

2

o

Flag as Offensive

moloe is not motivated by sound monetary policy. Shame on the Fed

Reply

Brewskie on Aug 10, 12:08 PM said: @Dee Woo: l\e been thinking to myself for sometime that as the next global economic crisis churns - resulting form the downturns in the US, China and the EU - it's quite possible the USD may benefit in the contest of the uglies: NOT because of economic fundamentals, but rather, because the US, in comparison to the EU and China, will be the least ugly contestant in the pageant. But don't kid yourself: we're in for some rough rides ahead, and we'll feel the pain here in the US.

o
Flag as Offensive

The thing that concerns me the greatly of China - and has been a focus of my research - is not whether China's heading for a crisis (she is), but the quality of her infrastructure. It seems so much 01 it deteriorates rapidly.

Reply

Eric Hofer on Aug 10, 7:09 PM said: @Dee Woo: Is China offloading US T-Bills?

o

o

Flag as Offensive

Reply

Dee Woo (URL) on Aug 10,7:49 PM said: @Brewskie: Iioloe your notion of" the contest olthe uglies". I called it" the contest of the screwed-up" in private. China indeed is hard-landing. The July CPI is out and is breathtaking. It's the highest in the past 3 years. There will be another around of QEs by central banks around the world. That will push China further off the edge.

o

a

Flag as Offensive

Reply

Kerry R. Stewart

on Aug 7. 5:55PM

said:

o

o

The article was facinating. I tend to agree with your analysis. The artificial deadline that Geitner of the treasury placed on the deficit default was Flagas Offensive a shock and awe tactic. I believe the Republicans gave away any advantage they may have had politically by not sticking to their guns and pressing for real reductions and not the namby pam by results they got. Most of the reductions don't elen kick in until after 2016. As a result, we see the S&P downgrade of the US credit rating for the first time eler in our history and rightfully so. The politicians in the US, both left and right, continue to play games instead of actually doing something straight up for a change.

Reply Giles Raymond DeMourot on Aug 7, 6:01 PM said:

o

o

Default was never really an option: all we saw was a bit of brinkmanship. Republicans and Democrats alike were waiting for the other side to blink, and elentually they both blinked. Oblliously the Obama administration and Tim Geithner in particular were bound to exaggerate the fallout from a default, which doesn't imply it would not hale had serious consequences.

Flag as Offensive

The article is right where it says that there is no other sizable asset pool other than US T-bills able to absorb the chunk of the $10 trillion worth foreign-exchange reserves piled in trade surplus nations. For some time people had been toying with the idea that the ECB could issue Eurobonds that would take some of the surplus, but the dire state of the Eurozone has killed the idea. Exporting countries such as China and Japan hale not other option than buying T-Bills lest they lose their main export market: there's a Mexican standoff there. Both nations howeler are getting more than concerned with the size of the US debt and the deficit that feeds it: there's a sense that it cannot go on foreler. Certainly the deficit-reduction agreement that was made part of the debt ceiling increase law won't change the situation lery much: S&P did not fall for it and downgraded the US toAA+. The US deficit which feeds the debt is decribed as structural, but it is well-nigh politically impossible entitlements. Another aspect is that the US will never hale -never meaning in the foreseeable futurein Europe and Asia after WW II forced US companies to manufacture locally rather than export from of the constituents -raw materials for instance- of the products they manufacture in Europe or Asia), protectionist than they used to be, the trend has been largely halted but cannot be relersed. serioulsy to attack the main causes of the deficit, in particular a positive balance of trade and payments. Nationalistic policies the US (though they import, from the US or from elsewhere, part and while the EU and to some extent Asian countries are less

Many in the US call for drastic budget deficit-reduction steps, but I hale yet to see a politically and economically-financially realistic plan to do so. Increasig taxes on business is no solution and closing tax-reduction niches will not produce huge additional revenues. Unless the US economy rebounds, something that in spite of the predictions of an abundance of prophets of doom may still happen next year, possibly after a second dip in the recession, things are going to e~lve from bad to worse. One cannot count on such a rebound, but if it does happen as it did in the Clinton era (though after a much smaller recession) it will do more for deficit reduction than any expenditure reduction scheme, thanks to much increased tax revenues. If there is no such rebound (I hale many reasons to beliele it will happen, but explaing them would require too much space here) then all bets are off and the US T-Bill market may elentually collapse as well as the US dollar.

Reply Carmela Micallef on Aug 7, 6:03PM said:

o
Flag as Offensive

The world economic picture has been, and still is, changing before our eyes. The USA and Europe hale immence depth of strength, the right political guidance coupled with the steady co-operation of BRIC's and all other G20 countries will lead to future world stability .... but there are many potential pitfalls along the way, not least the vanity olthe politicians!

There are some major 'elephants in the room' - BRIC's economic slow down - Eurozone, 1 currency with 17 fiscal policies - Pan Arabian world in turmoil - USA indebtedness with little commitment to change. Some major soul searchinmg needs to take place, personally I would like to see this 'bridge building' to a new world take place in a collectne atmosphere through G20 ... this forum helped stop the 'meltdown' in 2008 ... the leaders need to be leaders and work for the solutions that are to benefit the whole . Ultimately, I am an optimist with faith in good human beings building a belter world ..... also realistic enough to know that other human beings try to do otherwise! Let's work together and build on our respecthe strengths.

Reply Rahul Magan on Aug 7, 6:04PM said: Ratings cuts is not the solution of the problem and we all should concentrate on the upcoiming Neon Swan elent in the world.

o

o

Flag as Offensive

The Financial World is on the lerge of Crash. We all should oppose the increase in the US Debt Ceiling because we are simply posphoning the Credit Crash and not doing anything to sohe it . There was the time when US Debt Ceiling was $ 5 Trillion and now the same is $ 16.2 Trillion and one day the same will be $ 200 Trillion? Are we gilling anyvaluation to Internal Accruals? Are we really understanding the meaning of intemal Accruals or Debt is the only word?

Reply Eric Hofer on Aug 7, 6:05PM said: Neat points. Without the US buying, China would be in trouble. And, China buys T-Bills to demonstrate it's amity for the US. Also, that US debt underlies so much of the world's reserves ... And that makes me now wonder, what does that mean now that the US has been downgraded?

o

o

Flag as Offensive

Reply chris v dadole on Aug 7, 3:48 PM said:

I guess, plus ca change plus c est la meme chose. 8-)))

u

u

Flag as Offensive

Reply Bob Raffo, Jr. on Aug B, 2:40 !Wi said:

o

o

Don't be fooled into thinking that the American economy is immune to global competition. In the 1970's blue chip companies like IBM and GM Flagas Offensive were considered global empires that would newr falter. Howewr, their lack of sensitivity to a changing world market left them crippled and during the 1980's and 1990's Microsoft and Toyota emerged as new dominant world players. It may take another 10 or 20 years, but that is nothing in terms of socioeconomic transformation. We haw witnessed an inflection point in human history - get ready for a new playing field.

Reply Luiz Cezar Giacomazi on Aug 8, 2:43 !Wi said:

o

o

This is a special moment in history, although not american I really feel that this will be an opportunity for changing, not only in US but in Europe Flagas Offensive and as a consequence in the rest of the world. Ewrybody knows the importance of American market and there is no replacement for US$. Therefore in two or three months from now we wil see that most of the impact will be absorbed and real and important changes will start like the improwment in the efficiency in all countries affected, I really see this period as an opportunity.

Reply aritra chakrabarty on Aug 9, 7:57 PM said:

o

o

Fears are certainly out- stretched over the U.S economy. what needs more concem is the instability of the euro; whether nations are willing to compromise over their sowreignty for a fiscal union. Many economies are linked to the largest consumer base in the world; will it allow itself to go for a tailspin?

Flag as Offensive

Reply Gary Anderson (URL) on Aug 9, 10:32 PM said:

o

o

"S&P can't terminate the dollar's status as the world reserve currency."

Flag as Offensive

Is the author saying that the S & P is an agent of China, Russia, Japan and Europe, all creditors of the United States? And was this an allack on the dollar in premeditated fashion?

Reply John C. Drew on Aug 9, 11:26 PM said: I don't think the downgrade will mailer. Ewryone knew the U.S. was heading in the wrong direction before the announcement by Standard & Poor. Moreowr, big inwstors haw wry few attractive options for where to place their money - thanks to a weak global economy. As such, I suspect the federal gowrnment will still be able to borrow money at wry low rates.

o

o

Flag as Offensive

Reply Alex Song on Aug 9, 11:29 PM said: The AAA rating on US sowreign debt (i.e. Treasury bills, notes, bonds) has NOT been downgraded. Merely the "outlook", which had been at "stable" before, is now downgraded to "negatiw." S&P claims that a negatiw outlook means that there is approximately a 1/3 chance that US debt will be downgraded to the next debt tier lewl owr the next two years. The US has always had AAA rating since the formation of the S&P ratings agency The US debt outlook has newr been "negatiw" before, so this is rather unprecedented. Moody's and Fitch (the two other major ratings agencies) haw not changed their respective outlooks on US debt as of yet.

o

o

Flag as Offensive

The impacts of this are wry lillie, here are some general points that should be accessible to ewryone (I would low to talk about some of the more nuanced points privately or in the comments): The ratings agencies lost a lot of credibility in the recent housing crisis, in the sense that they really dent know what they're doing, how to evaluate credit risk, and are generally perceiven by people in the industry to be "behind the CUMl." They are seen as characteristically more reactbe than proactne in ratings changes. In this particular instance, no new information was produced. Nothing they said was news to the debt markets, all the information had already been priced in to asset prices. The market impact of the S&P outlook downgrade was hence wry lillie (In my opinion, the sell-off in equities was due primarily to poor Q1 earnings; US bond markets finished off the day strong, which wouldn't be the case if the credit was weak; and FX markets displayed but a mere knee-jerk reaction that quickly disappeared). The general reaction on Wall St (both buy-side and sell-side, domestic and foreign clients) has been that there should be lillie to no impact. If anything I think more people were interested in buying US debt following the announcement, due to the initial sell-off. An analysis of S&P "outlook downgrades" in the past rewals that much less than 1/3 of "negatiw outlook" credits are ewntually downgraded to the next lower rating. So either history is not an indication of future trends or S&P may be slightly mischaracterizing the risks of an actual downgrade, in their opinion. The hurdle for an actual rating downgrade is wry wry high. In the cases of Japan and Canada (both downgraded in the 90s), debt/GOP ratio were up to the 120% mark to trigger the downgrade. Current projections by the CBO sees the debt/GOP ratio by 2020 as between 70% to 85% (depending on if you look at the Ryan scenario or the Obama scenario). Hence, the probability of an actual downgrade is wry low. Most importantly: In my opinion it is functionally impossible in the long run for the US to actually default on its sowreign debt (as in it is impossible for the US to miss an interest or principal payment) because the debt is denominated in USD and the gowrnment can simply print dollars and payoff its obligations. Practically

speaking, creditors may find their assets erode in value lia inflation if the US simply prints a lot of dollars. Basically, in the status quo, for a credit event to occur with US sovereign debt, the US must intentionally default, as opposed to being forced into default by the inability to pay. The ultimate effect, if any, of this outlook downgrade would be mildly positive, in my opinion. As it would create additional pressure on Congress for fiscal discipline and debt reduction going forward. The best thing Congress can do is resohe the debt ceiling debate going on currently and create a long-term, credible, bipartisan solution to resolling budget shortfalls. That was a very simple treatment of a very complex issue. I know I've left a lot of important points out. I will likely come back to this answer and update it as time goes on and I digest more information.

Reply Eric Hofer on Aug 10,4:24 AM said: I share Dee's sentiments. While ailing in some fundamental ways, the US is a large consumer economy with a cohesive continental system. Other economies are less diverse. I'd expect, once the CHF and gold buying spree reaches their zenith, the money will then flow into the US to pick up assets cheapened by exchange rate movement.

o

o

Flag as Offensive

Reply lembit (URL) on Aug 10, 11:30 AM said:

o

o

The article was facinating. I tend to agree with your analysis. The artificial deadline that Geitner of the treasury placed on the deficit default was Flagas Offensive a shock and awe tactic. I believe the Republicans gave away any advantage they may have had politically by not sticking to their guns and pressing for real reductions and not the namby pam by results they got. Most of the reductions don't even kick in until after 2016. As a result, we see the S&P downgrade of the US credit rating for the first time ever in our history and rightfully so. The politicians in the US, both left and right, continue to play games instead of actually doing something straight up for a change.www.veccapital.com

Reply Rahul Magan on Aug 10,7:08 PM said: According to the latest published report at US Treasury Site - The National Debt of US is - $ 52 Trillion vs reported of $ 14.3 Trillion. There are various gross mishandlings in the report and the biggest amongst them is that the report is not as per US GaaP Accounting Standards. If all Financial Institutions are forced to make their books on US GaaP Accounting then why not the US Govt ?

o

o

Flag as Offensive

I disagree with the fact that it is too early to predict as US is already haling the realised National Debt of $ 52 Trillion and there is no exact valuation of National Debt with Off Balance Sheet Exposures & US Govt Contingent Guarantees hence we still have to wait? If the answer is yes then we are waiting fora great Neon Swan event ( by prolonging a Black Swan event)

Reply Brian Chapman on Aug 10,9:57 PM said:

o

a

Yeh. I think China is going to have a very hard time in the near future, if the USA cuts off their supply of US dollars. Flagas Offensive it won't really hurt the USA. It's not like we need imports from China or anywhere else. In WW2 were were able to completely reinvent American industry in a matter of months to produce high tech war gear. It really wouldn't take us but a fiew months to build the factories we need to replace everything we buy from China and elsewhere. As far as American "empire" ... So what? If we did this the entire world would be in shambles. Not much worth ruling over.

Reply Brink Lindsey on Aug 10,10:26 PM said:

o

a

We are in the early stages of resolling a huge and enduring incoherence in American political economy: for a generation now, the American Flagas Offensive public has wanted more govemment than it has been willing to pay for. For many years it has been painfully apparent to anyone who cares to face facts that entitlement spending, especially on health care, is on a growth path that will eventually require enormous tax increases to sustain. Yet thus far, any efforts to either restructure entitlements or raise the taxes needed to pay for them have run into a buzz saw of hostility from the electorate. But as Stein's Law tells us, things that can't go on forever won't. The current, unsustainable political equilibrium has endured as long as it has because of the govemment's ability to pile up debt. But that ability is being progressively exhausted, and so the looming choice between our relatively lalish welfare state and our relatively modest tax bill cannot be delayed much longer.

Reply Quenten Jones on Aug 12,2:05 AM said:

o

a

A very interesting article. One thing, however, that you fail to glean. There is a group within this country that has an appetite for power that is Flagas Offensive unquenchable. They really dont care what happens. In their estimation [from my liewpoint], they would rather see an Orwellian landscape however tinted rather than a free market society. And if that means some armed conflicts[Libya], riots{London and Hama], social upheaval[gay marriage initiatives] and the like, so be it. The more instability, the better. Even if it means a collapse of what we have now.

Reply

Join the discussion with your Facebook Login

I Add a corrrrent

...

Post to Facebook

Posting as Dee Woo (Not you')

I Comment

I

Pacebcck

social plugin