After the “Flight to Quality”, where is there left to go?
Chuck Ponzi August 8th, 2007
Over the past few weeks, as MBS holders have run for the hills, their flocks have meant that yields on Treasuries have depressed. A number of attributed this to a “flight to quality”. This happens whenever a risk reassessment happens. However, this flight to quality may only stem the tide of a massive tsunami.
In a dramatic turn of events, China has all but declared war financially on the US. China could overrun us without a single shot fired. It has even been referred to as the “Nuclear Option”. In short, China holds enough USD based paper to pound our little currency into oblivion. Don’t think it’s possible? Not only would I say it is possible, but the likelihood is in my opinion increasing daily. With trade sanctions all but the talking points of Sen. Hillary Clinton, China is revealing their muscle.
In old testament fashion, we have power to bruise their heel (trade sactions), but they have power to bruise our head (currency crash).
the Telegraph reports:
Xia Bin, finance chief at China’s Development Research Centre (which has cabinet rank), kicked off what appears to be government policy, with a comment last week that Beijing’s foreign reserves should be used as a “bargaining chip” in talks with the US. …
He Fan, an official at the Chinese Academy of Social Sciences, went further yesterday, letting it be known that Beijing had the power to set off a dollar collapse, if it chose to do so.
“China has accumulated a large sum of US dollars. Such a big sum, of which a considerable portion is in US Treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency,” he told China Daily. “Russia, Switzerland and several other countries have reduced their dollar holdings. China is unlikely to follow suit as long as the yuan’s exchange rate is stable against the dollar.
This has the power to dramatically readjust the equation of low mortgage rates. It’s not inconceivable that this adjustment could throw interest rates as much as 2% or 3% higher than they currently are. That would place mortgage rates in the double-digit range, and crush the homebuying public.
In a similar article:
Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress.
Shifts in Chinese policy are often announced through key think tanks and academies.
Described as China’s “nuclear option” in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels.
It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession. It is estimated that China holds over $900bn in a mix of US bonds.
In true idiotic fashion, Sen. Clinton sticks her head up her patootie with this one:
The threats play into the presidential electoral campaign of Hillary Clinton, who has called for restrictive legislation to prevent America being “held hostage to economic decisions being made in Beijing, Shanghai or Tokyo”. She said foreign control over 44pc of the US national debt had left America acutely vulnerable.
Bad news, Hillary, it’s already happened. We have the sword of Damocles hanging by a single horsehair. And China’s threats are not to be taken lightly. I don’t believe they like being bullied when we came to a gunfight with a knife. They’re holding all of the cards here, and we best stay on their good side.
What, you say? We don’t care?
A bill drafted by a group of US senators, and backed by the Senate Finance Committee, calls for trade tariffs against Chinese goods as retaliation for alleged currency manipulation.
What are our leaders thinking? Where is common sense and prudence? Have we learned nothing from our international bullying? I’m hoping this is more a reflection of general politics than a reflection on the best thinkers the Baby Boomer generation can muster. If it isn’t… my goodness we’re in trouble.
While worrying does nothing to help you prepare for the possibility, protecting your assets from a dollar crash is a wise approach at this juncture. It is unlikely that domestic stocks and bonds can offer the kind of security or gains that can be had with the dollar breaking through support levels and a whole lot of swords hanging over our head.
A 2-3% rise in mortgage interest rates will not kill the housing market, just hasten the collapse of prices. Most people don’t care what the interest rate or price is… only the monthly payment. If a $4000 monthly payment equates to $500,000 buying power, then they will buy a 500K house. Simple. If interest rates go up and lending becomes more restrictive so that their $4000 will only get them a $300,000 mortgage, then they will buy a 300K house. Most likely it will be the same house! (just with a nominal $200,000 price reduction)
What’s interesting about China is the combination of the 2008 US election and 2008 Olympics in Beijing. I’ve heard from many who do business with China that they consider it a matter of national pride that the Olympics go off smoothly, and that they want no political or economic disturbances of any kind that might ruin the games. So they may talk tough, but they likely will not dump treasuries until after the olympics.
US politicians may talk tough, but unless they are completely ignorant they know who wears the pants in this relationship. Still, what the hell is going to happen after the olympics and our election? 2008 will be a very eventful year.
Kurt,
good points, but I still think it would “kill” the housing market because the immediate disparity between sellers asking prices and buyer’s ability to pay would be substantially large.
Also, considering that within the last 3 years, you could have gotten fixed rates under 5%, having rates over 10% reduces affordability by almost 50% (depending on down payments, really).
What is just as insidious is what this does to general market sentiment. Just like there are opportunists on the way up, there will be plenty of people who will walk from their homes in “jingle mail” on the way down once they see their house has lost 40% of its value. The greater the loss, the more likely the propensity to walk for no reason. In addition, if it becomes widespread, humans tend to get emboldened by hearing other people doing the same thing. Think of C. Serin’s approach of “everybody’s doing it”. If that mindset gets ingrained… the housing market would indeed be toast until it could rebalance itself.
As it is, the market is having a hard time digesting the interest rates we have, and it hasn’t even addressed the issue of the credit crunch yet. You’re not kidding that 2008 will be a very eventful year. Likely the most eventful year in the history of the world with respect to housing.
Chuck
Yes, they do know who wears the pants… we do! China would be a HUGE loser in a trade war. The reason Smoot-Hawley was such a disaster for us was because we had a trade surplus with the rest of the world. Now if China (who btw, is the one with all the tariffs in place) starts a trade war, who will suffer more?
While I agree in principle, there is no winner in war. Only greater losers.
On that note, however, it depends on what you are fighting for. If it were China’s intention to punish us and our currency… they could certainly do so. They could basically crash our banking system. The fact remains that their currency holdings represent a systemic risk.
If we were fighting a trade war like Smoot Hawley, yes, but we’re fighting a currency war. We can win a trade war if they devalue the USD, but we can never win a currency war… we don’t hold enough Yuan to do so.
Oh goodness. What would be the point.
So they’d make massive inflation by dumping our currency which would kill off the trade deficit because we’d be buying less. Not to mention it would have almost the exact same effect as floating the Yaun.
Not to mention a large number of investors holding bonds would find them devalued.
That would have the effect of raising their currency. It would also cause us to raise tarifs and stifle trade.
I dunno. This is like good news because its going to stop the flow of jobs to China (for us working folks).
And if the trade with China stops us guys in the millitary buisness will be real freaking busy. Japan and other Pacific rim nations will buy weapons like crazy for protection from an agressive and pissed off China.
China just decided to have a duel with us in a small room and were both carrying hand grenades.
Do they realize the gun points in both dirrections? What a silly and childish thing to do.
Anyhow, probably good for me since we millitary/Aerospace guys were running out of people to fight.
Jackasses!
What happens to debt when the value of the dollar declines?
Am I misunderstanding a simple economic principle, or is a declining dollar beneficial to people who took on massive amounts of debt?
Only if it translates into wage inflation. Which is a likely outcome. Wages rise quickly, and former debtors who pay through to maturity win out. The key is whether it is a smooth transition or not. If it is smooth, it would be good for US industries to keep jobs here (putting wage pressures on us)
On the other hand, if you have to sell your home… the value of the asset is inversely proportional to the higher rates in the short term.
Higher rates are demanded by the marginal buyers of high quality bonds (treasuries). Basically, when China sells the treasuries, it has to sell to someone. To bring in marginal buyers of bonds, they have to offer greater discounts (higher rates). All other bonds and fixed-income streams are relative to treasury yields, since they are seen as zero risk.
If the country runs out of money, it just monetizes debt. That way, it can pay current interest by extending itself more credit (kinda like a negative amortizing loan). We all know how that work out.
Chuck Ponzi
If this happens most Americans won’t be able to afford putting ketchup atop their french fries. We’re barely making it as it is.
If it comes down to a gun fight those as****** are fu**** because we have the guns.
Plastic toys ain’t gonna help with what I’d send after em.
To further explain how stupid this all is…. If Paulson does NOTHING even the Chinese will realize buying up more and more debt will be suicidal.
They are gearing all their production around us buying stuff. As we get exhausted with the debt (we are close and accelerating to that point) the trade gap will close on its own. So it would be a slower and more orderly adjustment.
Dumping the debt=megadumb
One of my coworkers lived through some hyperinflation in Russia. He suddenly could pay off his housing debt. Great right? Problem was you couldn’t afford anything else and soon afterward it was clear their was no incentive to do any work.
Why work? Your dollars(rubbles) will be worhtless in almost no time at all.
Wow. How childish on China’s part.
I think you just answered my above question about what happens to debt when currency is devalued.
Chuck,
Where do you keep your money to protect them? Euro, BP, Gold, Ethanol?
Denis,
This is not investment advice.
I am keeping about 5% in Gold, 40% in foreign stocks, 5% in Insurance, 25% Cash, <10% index funds, <10% small-cap stocks, <10% yield-bearing insurance stocks in my taxable account. I am up 17% this calendar year as a result… results may not be typical and can change with the market. At one point, I was up almost 30% on the year, so I have taken a bit of a hit. I have kept much of my holdings.
Chuck Ponzi
China will do what’s in it’s best interest to get ahead regardless of what the US wishes to do…threatening another nation isn’t wise when there’s already one war going on. Let’s fight one war at a time.
This won’t happen. This is exactly equivalent to them floating the yuan. Funny to hear them threaten doing it.
I guess that guy doesn’t really understand why they have dollars instead of euros. Sheesh. Got to love that education system over there.
This would cause a much larger long-term disruption in the chinese economy by shifting low cost production to other third world producers with cheaper currencies(why they haven’t floated in the past and have so many dollars right now). While it would increase the short-term rates, it would strengthen the u.s. economy and cause only a temporary disruption in highly leveraged lending in the u.s. This would certainly cause a problem in the housing market, but only because its overvalued as it stands right now. The housing correction will occur regardless, and low-equity home-owners can easily dispose of their housing debt by just walking away and renting.
By my guess it would only take the u.s. about a year to absorb a trillion dollar expansion in M2.
To hear an export oriented country with relatively high tariffs, and a producer of commodity price-sensitive goods threaten like they did is absurd. Makes absolutely no sense. I wouldn’t be surprised if we hear about this guy getting executed for this.
have to lover their justice system and occasional deterent to repeat offenders
Fed and Eurofed are creating more money…
Aieeeee
Maybe a good time to buy more gold and silver?
Chuck
Fed is adding more cash today. More good money after bad (a good expresion from dad).
Oye vey.
I have a bunch of money in stocks, some cash, gold already.
Going to do some futures trading on the agricultural stuff. Family in the industry so good insights on shortages exc.
Perhaps but it’s so illiquid..but i guess some ETFs wouldn’t be so bad.
This is a little off topic but I think people will find this info useful. My husband and I have been looking for a house in the LA area and at first we were using Zillow, but after getting valuations that were not very accurate I tried housefront.com and found the information much more reliable. I was even able to use my cell phone to text message information about homes while we were driving around.
China’s holding a gun to her own head and threating to pull the trigger. If they dump treasuries and crash the dollar, won’t holders of dollar-denominated debt instruments bear the brunt of the pain? The US would effectively be forced to inflate its way out of debt. The problems for the US would be longer-term. With the dollar defrocked as a reserve currency, US imports would really start to hurt. That said, we could stop importing crap we don’t really need from China; the pain would be most acute for things we can’t easily do without, like energy. On the flip side, US exports would be helped greatly. The US could certainly rebuild its manufacturing base given the capabilities of its workforce and stable legal system. We’d be forced into putting our own house in order energy-wise, something we need to do anyway. Overall, we’re the ones with all the stuff, and the Chinese are the ones with IOUs - it’s lose-lose but seems to me China is the one taking the head-shot, not us.
Chuck, pull your head out. The US imports 25% of China’s GDP. Chinas GDP is 1/6 of the United States. What china does import from the US is mainly raw materials, which is neccessary for over 50% of China’s GDP. China won’t do crap. They always saber rattle. That’s more for domestic consumption than foreign.