Much attention has been focused recently on the potential impending crisis of sub-prime mortgages on the U.S. housing market. The past few boom years of soaring real estate prices both fueled and were fueled by a spate of irregular mortgages issued to financially insecure borrowers. Loans made on little or no collateral with widely variable interest rates have left many homeowners in danger of bankruptcy and foreclosure, as they find that their yearly interest rate has skyrocketed even as the value of their property has dropped far below its previous market price. Analysts fear that a wave of defaults could create a vicious cycle of foreclosures and fire-sale liquidations that would bleed U.S. real estate markets of massive equity.
While this situation is well reported, little has been said about its link to Chinese fiscal policy and U.S.-China trade relations. My brother, Lee Meyer, a securities analyst and salesman specializing in East Asian markets, observes an integral link between the forces sustaining the endemic Sino-U.S. trade imbalance and the growing crisis of sub-prime mortgages. China's foreign currency reserves have grown to 1.2 trillion dollars U.S. The reasons for this mounting pile of cash are well-understood: China has kept the value of the Renminbi (RMB) relative to the dollar artificially low so as to keep prices in China low and spur employment and economic growth. The ancillary effects of this policy have not been widely commented upon, however.
What relation may be drawn between Chinese fiscal policy and the sub-prime mortgage market? $350 billion of China's foreign currency reserve is held in U.S. T-bills. A further $230 billion of this cash, however, is held in bonds issued by U.S.-backed agencies such as Freddie Mac and Fannie Mae. These latter instruments are bonds that consolidate the debt of homeowners toward the purchase of their houses, much of which was generated by the issuance of risky sub-prime mortgages.
When one parses out the motives for Chinese fiscal policy, the link between it and the sub-prime mortgage crisis becomes clear. The PRC can only keep the value of the RMB against the US dollar artificially low by parking the profits from its massive trade surplus in U.S.-denominated assets. This has created a constant fund of cheap cash available to lenders in US housing markets. Bankers do not need to stringently calculate the risks associated with sub-prime loans because they know that they can always sell off that debt to an eager Chinese treasury in the form of a US-backed bond. The chronic need of the Chinese fisc to hypercirculate RMB has thus created a number of economic aberrations, including a Shanghai Stock-market bubble at home and a US real-estate market bubble abroad.
What the long term effects of this situation will be is anyone's guess, but most economists would agree that when there is a bubble it is bound to burst. The effects will not be good, the only open question is their ultimate severity. One lesson from the situation is clear: US complacency about the domestic political situation in China is self-defeating. US leaders express frequent frustration over Chinese fiscal policy and the distorting effect it has on Sino-US trade, but this ignores the deeper structural motives that perpetuate the anomaly. Chinese leaders continue to prime the economic pump that is causing securities and real estate bubbles for fear of the political consequences of any degree of economic slowdown. They hope that they will not be held to account for failing to deliver fundamental political reform as long as the Chinese economy continues to enjoy robust growth. How long this inherently unstable situation can be sustained is an open question. The political consequences of acute economic collapse are likely to be far more grave than the instability that might be engendered by proactive and preemptive reform, but this contingency does not seem to have registered upon China's leadership. If such an acute collapse does occur it will most likely cause the US suffering to parallel that of China, and at that moment America, having enjoyed the prosperity that inflated real estate markets brought, will have reaped the whirlwind.
You are right; the world is caught up in a global ecommerce system in which the central bankers do not understand the stages of a globalize currency cycle: that is the economical stages where the proper use of globalize currency leads a society to prosperity and the improper use leads a society to a bust.
ReplyDeleteOnce a central banker accepts a national currency as legal tender then that nation’s investors, savers, merchants, etc. must follow form and accept the currency as legal tender.
In the case of the dollar, most central bankers are waking up to the fact that they have no policy in place to withdraw the dollar as legal tender from their economic system if conditions warrant such a move.
China central bankers see the signs and are using their dollar holdings to buy assets in other countries, buying stuff from American Companies, etc. But China, as other central bankers, is acting in hindsight; as a result they are making poor investment choices.
The fact that America abused its “reserve currency” privilege simply means that the world central bankers are going to have to develop proactive policies to determine how national currencies can become legal tender in a globalize economy.
Not only China, but many other nations will have to write off their dollar holdings; the write off will be in the form of bad investment choices or simply realizing they can no longer accept the dollar as legal tender until our federal reserve adheres our currency to some form of globalize monetary standard.
Until there are globalize monetary standards, continue to expect central bankers to make wrong investment choices. And continue to expect the society’s investors, savers and institutions to respond in a like manner.
Once the dollar is no longer accepted as globalize legal tender then there is hope of salvaging some value from the dollar in a latter time frame.
Many old expired coins are now selling as collector items, so one piece of advice is convert your dollars to coins, with the expectation that at least US currency coins may become collector items.