China Bonds

OK, say you are a good little mercantilist and you want to keep your currency artificially low (so you can undercut the other guy’s industrial base, capture all the manufacturing business, drive them out of business, then jack up the prices once you are a monopoly… oh, and employ all your people while sucking in all the other guy’s money too…). How do you do that?

One way is a “currency peg”. You simply set your currency artificially low and announce it. (This is what China had done for several years, until the USA made it difficult enough that they very slightly loosened the peg.) A currency peg “has issues” in that as folks buy a boat load (literally) of your stuff, they typically don’t have your currency, they have their own currency. So folks in the USA buy Chinese plastic crap and hand over dollars. These then get sent back to China. Where the local company deposits them into the Chinese bank in exchange for Yuan accounts.

Sidebar: Back in “The Old Days” accumulating the other guy’s currency was not a problem as the recipient could just melt down the gold coins and re-mint them as their own gold coins. (Though usually it was just bars swapped between central banks anyway, so you could skip the whole melting / minting process unless you needed some more coins in circulation). You only had a ‘problem’ when you ran out of gold, and that was a pretty clear moment in time. Along the way, folks realized they were running out of gold and tended to not play the game out all the way to the end. Now we use paper currencies so the opportunites for entertainment are much greater.

Now that Chinese bank has the problem. Can’t pay the locals in US Dollars, so you have to convert those dollars to Yuan. OK… but now there is demand for Yuan and supply of US Dollars. That would normally push the Yuan up and dollar down (assuming other pressures balance out, and this IS a ‘trade imbalance’ in favor of China). At this point, to “hold the peg” the central bank has to do one of two things. Supply more Yuan, or soak up the dollars.

This ends up with the central bank up to their eyeballs in US Dollars or printing Yuan (that causes local inflation). The “fix” for this is to not print the Yuan, but buy it via issuing bonds instead (soaking in Yuan from those folks wanting to invest in Yuan Bonds, and handing them back out again as bank deposits in Yuan; so no net gain). Alternatively, you could simply take those dollars and use them to buy US Bonds (thus putting the dollars back into the USA where they become the US Treasury’s problem…).

But after you have bought a $Trillion of US Treasuries and with Congress looking like it’s on a decade long Crack Bender and smells some snow around the next corner… you start to wonder if you really will be paid back.

What to do… what to do… If you stop buying US Bonds, you must issue more of your own (and that depends on folks willing to buy them. But if you have been making your currency low, folks don’t like that. If the USA is trashing THEIR currency, and you are pegged to it, you are ‘trashy’ too.) So you can either keep the peg, and have a trashy currency that folks won’t buy in bonds, while you give your Stoner Client more goods and services and accept more “IOU Sukka” bonds from them… or let go of the peg. Which is what China did just a little bit many months back.

Big ships take a long time to turn, though, and this has been no different. Also, China did not abandon the peg, so the imbalance pressures are still there, only reduced a little. So where are we now?

This story is from the end of the year 2010. China tried to sell more bonds, and failed twice:

http://www.businessweek.com/news/2010-12-30/china-fails-to-complete-bill-sale-for-second-time-in-one-month.html

China Fails to Complete Bill Sale for Second Time in One Month
December 30, 2010, 9:06 PM EST

Dec. 24 (Bloomberg) — China’s government failed to draw enough demand at a bill sale for the second time in a month as seasonal demand for funds and higher reserve-requirement ratios left banks with less cash.

The finance ministry sold 16.76 billion yuan ($2.53 billion) of 91-day securities, falling short of the planned 20 billion yuan target, according to a statement on the website of Chinabond, the nation’s biggest debt-clearing house. The average winning yield was 3.68 percent, higher than the 3.22 percent rate for similar-maturity debt in the secondary market yesterday.

OK, so they wanted to sell Yuan bonds to get the cash to give to the banks (instead of printing it) and failed. This, then, means they either leave the system starved of cash (which strengthens their currency that they are trying to keep pegged to the plunging real value of the US Dollar as we print them $Trillions at a time … notice they are waaaayyy down in single digit $Billions here…) or they trade their ‘reserves’ (ie US Treasuries) for Yuan on the world market (and strengthen their currency) or print a boat load of Yuan (that worsens their inflation – that is already worse than ours in the USA as they have a booming economy with rising house prices and we are being slowly killed having our economic blood sucked out of us; so not a lot of extra cash to drive up prices. Besides, all that cheap Chinese Crap is holding down our cost of living…)

Further down in that article, we see folks worried about the internal impacts of the Yuan printing:

China needs to return to a “prudent monetary policy” to curb prices and control money supply, the People’s Bank of China said in a statement posted on its website today. While inflation pressures are rising, regulators will allow reasonable growth in lending, the statement said.

“Banks are badly short of cash,” said Qu Qing, a bond analyst at Shenyin Wanguo Securities Co. in Shanghai. “Given the cash squeeze, the central bank probably won’t announce any tightening measure by the end of this year.”

The rest of that article has details like actual interbank rates inside China and other things that economists care about. Then there are these bits:

The cash shortage has also sapped demand for bills sold by the central bank. The monetary authority has sold 1 billion yuan of one-year bills at each of its last four weekly auctions, the lowest sales amounts since October 2007.

“The market is desperate for cash,” said Chen Liang, a bond analyst at Guohai Securities Co. in Shenzhen. “It’s too costly to park money with debt at such a price given the seven- day repo rate has risen above 5 percent.”

So as inflation has picked up (due to the USA printing like crazy and China trying to hold a peg) putting money in Yuan Bonds has lost attraction. Right when they want to sell bonds the most, demand softens. That’s economics for you… The Invisible Hand is very hard to beat in the long run.

Now, notice in the next bit that they say the bonds are yielding 3.x and inflation is at 5.x (it’s not hard to make that calculation… I can lose 1.x of my money if I buy Yuan bonds?

Accelerating Inflation

The yield on the 3.67 percent note due October 2020 was little changed at 3.81 percent, and the price of the security was at 98.89, according to the China Interbank Bond Market.

The finance ministry sold 11.55 billion yuan of 91-day bills on Nov. 26, less than the planned 20 billion yuan. The average yield was 2.74 percent. China’s inflation accelerated to a 28-month high of 5.1 percent in November, the statistics bureau said on Dec. 11.

This is what you would call a “currency war” or a “race to the bottom”. And the USA wants to “win” this race…

The yuan has risen 0.3 percent since Dec. 6, when 30 senators sent a letter to Chinese Vice Premier Wang Qishan calling for the yuan to “appreciate meaningfully” before President Hu Jintao’s visit to Washington next month.

The currency strengthened 0.24 percent to 6.6270 per dollar as of the 4:30 p.m. close, the biggest advance since Nov. 9, according to the China Foreign Exchange Trade System. It’s risen 0.43 percent in the week, the biggest weekly gain since October.

Also of interest is that some of the local banks may be side-stepping the China Central Bank (and working against the Central Bank policies). This is a bit of an act of desperation:

“Some banks may be buying the local currency in the foreign-exchange market because it’s hard to borrow money in the fixed income,” said Li Tao, a foreign exchange trader at Shenzhen Development Bank Co. in Shenzhen. “There is also concern the appreciation may get quicker before President Hu’s visit.”
[…]
–Judy Chen. Editors: James Regan, Ven Ram

To contact Bloomberg News staff for this story: Judy Chen in Shanghai at xchen45@bloomberg.net.

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net.

Oh, btw, the Congress needs to think through what happens when it DOES win this race. Yes, you have a printing press and clearly you know how to use it. But perhaps knowing how to NOT use it would be better. Because WHEN you succeed, you will have made Chinese goods more expensive. And that is going to suddenly hurt the US population who have come to depend on China for substantially everything other than cars (but give them a bit of time…) and food. There will be a sudden and very painful spike in US Inflation rates. That will then spike bond yields which will result in a great increase in US Bond debt service payments. I.E. the deficit will be even more obscene and out of hand.

Back in ‘the old days’ mercantilists were dealt with by putting on a tariff until they got a clue. This would sometimes lead to a bit of a trade war, with reductions in trade and countervailing tariffs until someone gave up. But at least we didn’t have to destroy the life savings of everyone in the country in the process. The Dollar was “good as gold” because it WAS gold. That reduced the opportunity for these kinds of shenanigans.

But those days are long gone. We now (thanks to Mr. “Tricky” Dick Nixon) have a rubber currency being inflated like a cheap balloon. Just watch out for that “pop” at the end… The “good news” is that so far we’ve had most of that inflation show up overseas in other countries and in commodities priced in dollars. The “bad news” is that this has brought with it food riots, the downfall of a couple of countries (and counting…) and when the “pop” comes, it will come flooding home to us. (But don’t worry… Ben Bernanke is sure he can think of something in time…)

OK, so what is China trying now? Afterall, the Yuan bond sales were a dud. What next? It can’t print Yuan with that 5+% inflation and rising and hope to avoid a massive inflation hit and even worse bond sales.

http://www.guardian.co.uk/business/2010/feb/17/china-sells-us-treasury-bonds

China sells $34.2bn of US treasury bonds

Analysts fear Beijing’s move may suggest a loss of faith in American government’s economic policy

Tania Branigan in Beijing and Heather Stewart
guardian.co.uk, Wednesday 17 February 2010 17.11 GMT

We saw before where China traded $200 B of US Treasuries for oil rights in South America and more for some other mining rights and future coal deliveries. Now they are resorting to open sales of US Treasuries. And in non-trivial amounts.

China sold $34bn (£21.5bn) worth of US government bonds in December, raising fears that Beijing is using its financial muscle to signal that it has lost confidence in American economic policy.

I’d say they lost confidence a year or two ago (and about 1/4 $Trillion of US Bond dumping ago…) and are only now running out of folks willing to trade 30 years of resources for US Paper…

US treasury figures for the period ending in December 2009 show that, following the sale, China is no longer the largest overseas holder of US treasury bonds. Beijing ended the year sitting on $755.4bn worth of US government debt, compared to Japan’s $768.8bn.

Remember how much news there was over China surpassing Japan? Well, they are headed the other way now and going as fast as they can while not completely screwing their trade mercantilist policies. Japan, desiring to bugger the Yen so as to get more trade, is now soaking up the US Bonds. Welcome to The Race To The Bottom, boys… “Anyone need a nother fifths of Buorbonn? WEsh makss a lots of it in thhe UShA…” “Drink up me hearties Yo HO!”

But the news intensified concerns about China’s appetite for bankrolling ever-widening American deficits. Premier Wen Jiabao told reporters last year: “We have made a huge amount of loans to the United States. Of course we are concerned about the safety of our assets. To be honest, I’m a little bit worried.”

“You see I’ve forgotten, if they’re green, or they’re blue…”

Don’t worry Wen, your assets are safe. We can print more dollars for you any time you want some more… and can you send us some more steel, shoes, socks, jackets (bit snowy out) and some room heaters and toaster ovens and maybe even some laptops and a few more tires (snow tires would be good) and…

But it’s not like they are a fickle trading partner that might do something irrational (or perhaps very rational as it would be an easy excuse to ‘take the money and run’…)

http://washingtonindependent.com/76320/china-threatens-to-dump-u-s-treasury-bonds-over-taiwan-arms-sales

China Threatens to Dump U.S. Treasury Bonds Over Taiwan Arms Sales
By Megan Carpentier | 02.10.10 | 4:13 pm

Majors General Zhu Chenghu and Luo Yuan and Colonel Ke Chungqio of the Chinese People’s Liberation Army were quoted in an official Chinese publication calling for the Chinese government to retaliate against the United States economically for the recent decision to sell $6.4 billion of arms to Taiwan. China has already announced unspecified sanctions against U.S. companies that participate in the sale.

Luo, also a researcher at the Chinese Academy of Military Sciences, doesn’t think those sanctions go far enough. He told China’s Outlook Weekly:

“We should go in for a strategic mix of retaliation across politics, military matters, diplomacy and economics… For example, we could sanction them using economic means, such as by dumping some US government bonds.”

The article goes on to make the same points as here, that dumping US bonds would be economically difficult for China in the face of the mercantilist desires.

But, you never know….

I would also note that in addition to selling food, military equipment is one of our few major global exports. So, like it or not, we are an arms merchant to the world and would benefit from a ‘bit of war’ here and there. Just because we are increasingly despirate for some real money and need to export SOMETHING, doesn’t mean we’d sell arms to just anyone. They have to be at least as sane and trustworth and “good folks” as the Shaw of Iran, Saddam Hussein, Mubarak, and Pakistan… I’m sure China has nothing at all to worry about… I mean, it’s not like we’re selling billions of dollars of arms to India with whom they have had wars on and off over the years… Oh, wait, we have:

http://www.reuters.com/article/2009/03/16/us-india-usa-arms-idUSTRE52F6X520090316

But hey, shoes, tanks, what’s the difference? Commerce is commerce…

In Conclusion

I would expect that the USA will continue to print and spend into the $Trillions of excess and China will try to edge for the exit, $20B to $100B at a time, and that eventually the USA will “win” this Race To The Bottom. Along the way some other folks, like Japan, will pick up some of the credit card but in the end, the USA will have a massive increase in costs for basically everything the typical American family buys. (What we don’t buy from China tends to be Japanese… think Honda, Toyota, Nissan, Nikon, Cannon, Sony…)

The other big issue here is that the US Budget as proposed by Obama has a $1T scale gap in it. With China cutting back on US Bonds, and Japan not quite able to pick up just the amount China has dumped: Who will be buying that $Trillion PER YEAR for the next several years?. Face, meet floor.

China will end up with needing to “accept” that it will have a monopoly position on things like socks and toasters and we will just need to pay a higher price for them. I’m sure they will be all broken up over it…

And we, in the USA, can take solace in having WON the Battle! While we realize that our $100 US Savings Bond might, just maybe, buy a tank of gas… but not a weeks worth of groceries, nor even a dinner out at a high end restaurant….

IMHO, we are watching folks jockey for position for The End Game in this event. Since the outcome depends on decisions of individuals who are sworn not to give clues, it can not be seen in advance. But what I would expect to see are continued crop failures in China (as we’ve turned back to the 30 year volatile and cold weather half cycle) and increased appetite among the Chinese for better food. This will result in China buying even more grains on the open market and dumping dollars to do it. That will result in more “bread riots” elsewhere in the world (Africa, poor parts of Latin America, some of South East Asia and South Asia) and more governments will fall.

Eventually the USA will “win” and we’ll get a bit more “competitive” in world trade; but at the expense of having impoverished every holder of US Dollar denominated financial assets. Quite a price to sacrifice on the altar of Global Free Trade… And we will buy less Chinese product. Not because we want less, but because we will be paying more for it, but have fewer dollars of lower value.

The good news is it will be easier to get a job. The bad news is that you will need two of them to make ends meet and the country will be impoverished. Oh, and it might result in a heavily armed world on the verge of W.W.III, but that’s not much different from where we are already…

Subscribe to feed

About E.M.Smith

A technical managerial sort interested in things from Stonehenge to computer science. My present "hot buttons' are the mythology of Climate Change and ancient metrology; but things change...
This entry was posted in Economics - Trading - and Money and tagged , , . Bookmark the permalink.

25 Responses to China Bonds

  1. kuhnkat says:

    It’s worse than you thought!!

    Have you seen the articles on China’s GHOST cities?? For whatever reason they had a huge buildout of real estate that apparently cannot be purchased by anyone. This is part of why I keep hearing rumours of China housing bubble I believe. Do you have any hard info in that area??

    http://www.businessinsider.com/pictures-chinese-ghost-cities-2010-12?slop=1

  2. George says:

    There are a couple of alternative scenarios:

    1. The US dollar is dropped as the world reserve currency and that role is filled either with the yuan or a basket of currencies that includes the yuan.

    This increases the demand for the Yuan and, actually, the China is now in the role the US was in when the dollar assumed the role of the world currency. As China is the primary consumer of raw materials and the primary producer of finished goods on world markets, it makes sense that their currency be used.

    2. (and this isn’t as flippant as it sounds) China adopts the US dollar as legal tender so it can then pay its people with dollars. If you are going to maintain a peg, then adopting the pegged currency as legal tender helps maintain that and prevents either “winning” a race to the bottom.

  3. pyromancer76 says:

    My, my, my. The person behind the face that meets the floor is going to be mighty pi$$ed. I wonder who “they” will blame? What will the politics of this look like?

    The one reason why I think we might be able to turn the corner this time — end “big government” — is because we all (even the AGWers in their deepest minds) understand that American affluence is rapidly waning. Energy dollars are at the core of this turnabout; we export way too many of them. You mentioned 1965 in the last post. I think there was too much optimism then (the transformation of the Civil Rights movement was utterly amazing — a true march toward expanding democracy) and we enjoyed “too much” affluence at that time. The reality of spending and inflating our way to fiscal hell could not be noticed.

    However, once the oil crisis of the 1970s hit, it has been downhill ever since. Today everything hoped for by middle class families for their children will be much, much harder to come by. This is a new reality. And god help us if (when) hyperinflation hits. I do believe in the American history of “great awakening” moments/movements; they have been transformative. Can we Americans return our paper to a gold standard? Can Tea Partiers continue to defeat both Republican and Democrat spenders? (Are we fed up with the scammers?)

  4. bruce says:

    I was wondering about the plight of all those near retirement or in it, with assets in conservative positions, when the dollar’s worth is much lower. Social Security recipients will be hit hard but folks with savings will be hit harder.
    The deficit will require cuts to SS, its not going to be pretty.
    Those who have managed their retirement needs will find their millions won’t buy that yacht.

    I suppose the end will be near when we realize that point and try buying everything before the crash.

  5. R. Shearer says:

    It doesn’t look good. I hope our Wall Street slickers can do to the Chinese what they did to the Japanese.

    Anyway, this race to the bottom is not sustainable. Energy expenditures are troublesome for us, but we only have just over 300 million to feed whereas China has almost 4 times that. Plus, acre for acre our farmers can’t be beat.

    I visited a couple of communes within China in the 1980’s. The farmers were proud of their personal stashes of grains, mainly rice because they had lived in famines and other hard times. China could have huge problems from a return to hard times resulting from crop failures. The sex disparity from the one child rule could also create significant societal problems. Prostitution in China is a lucrative business but it must weaken its society.

    This is the Asian year of the hare. Confusus say, hare can run too fast and die from exhaustion.

  6. R. de Haan says:

    Great article, I really think you are correct with your assessment and China and the USA will fight this to the bottom at a horrible price.

    The current food riots will be a walk in the park as we arrive at the middle of the upcoming summer.
    Both Europe and the USA are boosting their bio fuel policies. Every citizen earning less than 2 us dollar a day will be confronted with famine and people will start dying as flies.

    And if this report is true, we can say bye bye to huge number of our world population short term.

    At a moment in time that we call “bad timing:

    http://www.google.com/url?sa=t&source=web&cd=1&ved=0CBUQFjAA&url=http%3A%2F%2Fwww.spaceandscience.net%2Fsitebuildercontent%2Fsitebuilderfiles%2Fssrcresearchreport1-2010.doc&rct=j&q=ssrcresearchreport1-2010.doc&ei=TwBbTbzFAcP6lweQrO3aDA&usg=AFQjCNF1HJD0MjijaKaU08YRd-OKCPNaQQ&sig2=r0Gp-ZmUW9FcSx29brYZdw&cad=rja

    And I am an optimist.

    Debunked many times, also at this site is the lie of Peak Oil but our Governments prepare for policies going into the direction of fossil fuel prohibition and food – bio fuel rationing.

    Click to access Organised_crime_in_energy_supply.pdf


    That’s in the former Free West if the UN, EU and Obama get their way.

    If they get their way.

    Dr. Richard North has another idea.
    http://eureferendum.blogspot.com/2011/02/we-are-revolutionaries-now.html

  7. P.G. Sharrow says:

    E.M. , your post reminds me of the discussion my long time business friend and I had Saturday night. It centered around China, near term economics, going back to commercial farming/ranching and a case of Sudwerk beer. The beer was good. The China bubble looked about done, and we may be too old to take advantage of the coming boom in farming. :-( damn! that was one occupation that we both enjoyed. pg

  8. mddwave says:

    IMHO
    The scenario that concerns me the most is oil going above $150 per barrel. The last time it seemed to be the trigger for the “shock wave”. When Americans pay $5/gallon for gas, there begins to be a cash flow issue in homes, the nation, etc.. I am noticing the $3.10/gallon plus price now in my family budget.

    If I were the Chinese, I would buy some natural resources with the dollars received for the exported goods. The natural resources have storage costs to store wealth, but natural resources can still be consumed. An inflated dollar cannot.

    With the price of oil in the worlds currency reserve inflating dollars, the price of oil would obviously inflate. Over the last six months the price of oil has been increasing at a high rate. Without a major change in US fiscal policy, it will continue until the economic strain is too great.

  9. E.M.Smith says:

    @R. Shearer:

    China has about 20% of world population but 7% of ‘arable land’. (We CAN make more ‘arable land’ so that’s why I put it in quotes…). That they are at (rough) food parity means they are doing something right.

    However, if things get at all bad (as they did with this last drought related crop failure) they are in food deficit.

    OK, but that statistic also means that 93% of the ‘arable land’ is not as intensively farmed and / or the food it produces is not used as efficiently for food. (Think ethanol fuel and corn fed beef…) So at least in gross terms, we ought to be able to support 93/7 ~= 13 13*0.2 = 2.6 times as many people on the planet as we do with current means (as a very rough estimate with loads of loose ends).

    That’s a very round about way of saying that if we all ate more noodles, rice, and vegetables and fed less corn and soybeans to cows and pigs, we could support a lot more people.

    So if things get bad, think cornbread and tofu…

    (You still need a fair number of ruminants like cows, goats, and sheep; they are the ones that can eat the stems and leaves that we can not eat. Max productivity from the land is in a mixed diet that includes meat and dairy… just more grass fed than at present.)

    BTW, the “big issue” with the one child policy is that of “retirement”. We have a fairly bad retirement issue as there are “only” 2.x workers per retiree. Now think what happens when that is 1 worker per 2 retirees and it has sudden onset in a single year (when the policy took effect).

    There is no way one guy can support two retired parents. Or worse, one couple support 4 retired parents and one child. Not and stay sane. And it doesn’t matter how you pretty up the picture with finanical instruments and hiding behind insurance plans and “whatever”. In the end, there are only real physical people to empty bed pans, grow and cook dinner, and clean the house… while making shoes and driving trucks and…

    So the “demographic bomb” is going to be a major issue for China.

    Egypt is an example of the other extreme. 60% of the population under 30. But they did not have an open economy with free investment of capital. So a load of folks got college degrees that were not usable for work in their country. Now they are all standing around unemployed wondering what happened. They have a 90% unemployment rate in that cohort. Soo…. “Kids” who are “20 something” are living at home unemployed as their parents are spending whatever savings for retirement they had to put food on the table. They have the labor force, but not the captal stock to put it to productive use, and had policies that choked outside flows of investment in (i.e. graft, corruption, the kings share…)

    They, too, have a “demographic bomb” but it is going off right now. The good news is that with some change of policies, they can leave their problem behind. Just turn the people free and they will build a thriving economy and industry. So they are turning themselves free. (Iran had the same problem, but got captured by another broken policy system so are now having the same ‘demographic bomb’ problem…)

    Unfortunately, there isn’t really a way to put the Arab labor together with the Chinese capital stock (though I’m sure folks will try to find a way). Just like importing Turkish labor into Germany has not worked out so well.

    I suppose the only ‘good news’ is that it will be a decade or three before China blows up. Maybe.

    @Bruce:

    The fallacy of our present retirement is “the demographic bomb” as I’ve called it. It doesn’t matter how many T-bills you own. There simply will not be enough young folks working to take care of all the old folks in the “baby boom” when we retire. It simply must break. The only questions are about “break for all or only for some?” or “break for which groups?”

    In my opinion, it will be “broken” by buggering the dollar. That way the US Government can claim to have paid off all dollars owed, it just won’t pay the rent or buy any food, so you will need keep working even in ‘retirement’.

    FWIW, that’s part of why I’ve gone an taken my ‘retirement’ in the middle. I’m living on my assets now so that when means tests are put in place, I’ll not be screwed by that particular finagle. And when I have to join everyone else going ‘back to work” I won’t have to worry about ‘never getting to retire’. I’ve already got it in the bag…

    Yes, it’s a high risk strategy in the sense that if I’m wrong I end up in a much poorer “late retirement”… so I’ll have to content myself with having spent far more years gardening, fishing, and thinking about what I wanted to think about than expected… ;-)

    I already own a home and all the cars I’ll ever need. Don’t really want any more “stuff” (modulo a few toys) and mostly would just miss out on some travel to places that I’d probably not really care if I missed them… ( I’d like to see the pyramids of Egypt, for example, but if it never happens, well, I’ll just have $4000 worth of more gardening supplies and time at the beach…)

    @Kuhnkat:

    They have a tremendous rate of migration from the country into cities. They also still have the Central Planning monkey on their back. “Stuff happens”… When an economy is moving as fast as their’s has been moving, it’s not a big surprise that some things get screwed up. I once visited a subdivision in Florida that was mothballed. Out in the middle of nowhere. (Turned into the main entrance in a blinding downpour, then could not find my way out). It was a ghost town of streets with streetsigns, but no homes. Well, there was ONE off to one side. Eventually I found may way out. A decade later it is a thriving community with canals to each home and private docks. Fully subscribed. I suspect things like that are what’s up in China too, just on a larger scale.

    Would I buy land in China? Not right now… But do I think this means China is doomed? Not with one of the largest growth rates in the world at the moment. And the Chinese central committee can always just keep these mothballed for the day they get back on plan. Not like a private enterprise where you go out of business and the bulldozers come in.

    @George:

    They won’t drop the dollar. They will most likely go with a basket of all ‘major’ currencies. The basis of a new World-Unit of currency. One Universal Note, call it the UN for short…

    China could just adopt the US Dollar, but that “has issues” too. For example, right now we are “stimulating” and they need “contraction”. The whole problem that they have right now is from having THEIR domestic “stumulus” tied too closely to our currency (for mercantilist goals) and our central bank. But yes, they could make it even more tightly bound, and have no ability at all to adjust monetary policy… Then we could create even more ruinous inflation and they could do absolutely nothing about it…

    @Pyromancer76:

    The major open quesiton about the fall is “How fast?”… after that comes “Who can I blame it on other than me?”…

    It would be very hard to return to a gold standard. For one thing, we’d need to buy about $1 Trillion of gold for making into coins… The price of gold would blast through the stratosphere and we’d end up with one coin being worth about a car… until we were done with the conversion, then things would drop back to about $8,000 per ounce (IMHO and without a lot of backup research).

    It would be “easier” to do it with issue of a new currency alongside the old one. Issue a “$2000 Gold Piece” of about one ounce, and a $1000 coin of 1/2 ounce and a $500 1/4 ounce coin. Maybe even a $20 “Gold dime”. Let them circulate as you add the $50 “silver ounce” and the $5 “Silver dime”… Keep them convertable and slowly let the paper come out of circulation over about 20 years. Withdraw the $100 bill first, then the $50. Eventually replace the $10 and $5 with nickle/copper coins. Don’t know if you would want a $20 silver “quarter” or not…

    If you start with a high enough face value, it’s not worth melting them nor cashing in paper to get them, but as inflation happens it slowly brings the noose tight around the paper currency until it is all driven out of circulation. And with 20 years for mining, you could mine enough metals to do it.

    FWIW, I’d let the “exchange rate” between gold and silver coins float. I’d not even put a number on the coins (as we don’t now… just ‘silver dime’ or “silver quarter”.) That way you don’t care what technological things happen to relative mining rates. People can cope with decisions like “I’ll take 10 silver quarters vs I’ll take 1/10 ounce gold…” It happens every day when we buy things… AND it ought to only happen on transactions that take over $500, so it’s not like this is an every day thing. Your mortage would state “payable in gold dollars” or “payable in silver ounces” or whatever. (That is how contracts were done in the past…)

    But it will never happen.

    You MIGHT be able to make a change where you re-issued the $1000 and $500 bills and put on them the old promise to pay in “lawful money” but spell out how much. This many ounces of gold, or that much silver. Just set it higher than at present and start printing. Slowly withdraw the $100 with no promise to pay, and replace it with one that promisses sliver. Then do the $50.

    At that point you are close to done. You can start minting some equiivalent gold and sliver coins and lef folks choose which to carry. It effectively throttles the quantity of paper that can be printed but without the need to up-front come up with One Billion Ounces of gold… ( About 2400 tons of gold are mined per year. Don’t know if that’s short or long tonne but call it 32,000 troy ounces per ton. Now you’ve got about 1.3 years worth of total global gold mining needed to make your coinage. “that’s gonna be a problem”… there’s only 147 million troy ounces of gold in Fort Knox…)

    Now, I could be off on how many ounces of gold it would take to support our economy; at about $14.7 Trillion per wiki… Odd, that’s almost exactly one ounce of gold in Ft.Knox for each $100,000 of economy. At about $1000 per ounce, that would imply if all of it were ‘in circulation’ that the velocity of money would be 100 changes of hands per year. Seems a bit high to me… On the other hand, I’m saying that an ounce only changes hands about 14.7 times per year (14.7 $T / 1 B ounces = $14700 at $1000 / ounce would be about 14.7 X a year) times per year. Probably low. In between is the truth. But at any case, the mines of the world would be busy for many years (as you can’t really buy ALL the gold mined in any one year) and we would have to come up with a big bucket of money to use to buy that real money… But spread it out over 20 years, it’s a 5% of production number. That’s achievable. Especially if you can keep, oh, I don’t know, 50% to 80% of transactions going on the electronic and / or paper side?

    In short, while I think you could fairly easily go to a gold PEG, I don’t think we could get back to gold MONEY very easily. Folks just love their plastic money too much.

    What I suspect would be much more easily achieved is a constitutional amendment that limits government to, oh, 10% of GDP or mandates no more than 10% of the budget be carried as debt in any one year… or both. Frankly, I think it would be fun to watch the fireworks if we just set the Federal Budget to $2 Trillion period. We’d see a prolonged period of deflation “right quick” as the only way the congress critters could get more ‘real value’ to spend would be to make each dollar worth more ;-)

  10. E.M.Smith says:

    @P.G. Sharrow:

    Saw an interesting show on Deutsche Welle (IIRC) about the commercial expansion of cloning in the USA and S. America with it being fairly common for “Price Bulls” for example to be clonned. Then the clones can be sold with or without their own cloning rights….

    Soo…. You could get in on the farming “boom” via the expedient of a single animal… Buy a ‘prize something’ and sell clones… You can, if you pardon the pun, “farm out” the actual process of getting the clones made…

    The EU Folks were all in a tizzy that “son of clone” meat might already be in the EU “On Our PLATES!!!!” OH NO! Mr. Wizzard!

    As I’m married to a clone, I don’t see the problem. Yes, she is an ‘accidental clone’ as a natural identical twin, but, well, that fits the definition….

    But at any rate, if you’ve thought of settling down to your golden years with a couple of “pet” animals to remind you of the “good old days”… realize that with thoughtful selection of pet and cloning rights you COULD be in the farming business with one animal…

    The interviewed one guy who was participating in an auction (where most of the bidders were watching on web cams) and said “Strange business you are in” to which the farmer replied… “No… not strange. Just business”.

    http://www.mindfully.org/GE/Cow-Clone-Firms.htm

    If you don’t want to pop for the $50,000 cloning fee yourself, you can buy the base animal, then sell ‘cloning rights’ and someone else can make a clone from them selling you a royalty. You can choose to withhold from them further cloning rights of the animal they get. (So, for example, they could get a prize bull clone for breeding into their herd, but could not make a further clone of him in competition with you.)

    In this case (in the link) a clone of the cow went for over $80 k, so the ‘premium’ above cloning costs was about $30k for the delivered clone…

    Maybe a bit pricey as a business (don’t know your ‘means’) but that’s what partners are for ;-)

    FWIW, they had, in the news film, a bull being managed and cloned by some folks where the “owner” was no where near (off in some other state). So there is a complete spectrum of choices from “owner” to “breeder” to “run cattle” to … any and all pieces together or in isolation.

    Strange business…

    @mddwave:

    We’re at $3.60 / gallon on the Left Coast for premium and / or Diesel with about $3.35 for regular. And rising.

    The “summer driving season” is going to be interesting…

    Yes, oil is a ‘commodity currency’ in it’s own right. I’d own it here. Mostly as oil trusts (as I’ve talked about before) but also as oil sands plays like IMO and SU. (Check the chart before you buy, though)

  11. R. de Haan says:

    mddwave
    IMHO
    “The scenario that concerns me the most is oil going above $150 per barrel. The last time it seemed to be the trigger for the “shock wave”. When Americans pay $5/gallon for gas, there begins to be a cash flow issue in homes, the nation, etc.. I am noticing the $3.10/gallon plus price now in my family budget.”

    Why don’t you convert your car to Liquid Petrol Gas?
    The LPG is cheap and you can do the conversion yourself. Great kit offers on the web, like this one:
    http://cgi.ebay.co.uk/LPG-Conversion-Kit-5-6-8-Cylinder-Sequential-KIT-/320655128405?pt=UK_CarsParts_Vehicles_CarParts_SM&hash=item4aa888f755#ht_6059wt_1141

    Just bought a 2002 Range Rover in the UK (Left steering, low milage, no rust) for a little money and an LPG kit (for an 8 cylinder engine) for two 25 gallon tanks to fit under the Rover chassis for about 600 US dollar.
    Will use the car for the bad weather conditions with snow and ice in Germany where we already reached the price level of 7 USD a gallon.
    http://www.impco.ws/automotive-product.asp

    LPG saves me about 50% of the fuel costs, less engine wear and a smooth ride.
    I’m told LPG in the USA is even cheaper since their is no coupling between gasoline and LPG/CNG prices.

  12. David says:

    EM, great post and comments. In regard to Egypt,” So they are turning themselves free” I’m only wishing E.M. But the cry of the youth there is for more govt, just a “kinder” govt. They are demanding higher pay and govt solutions. Who, anywhere in the world, promotes individual liberty and responsability anymore?

    Our odd position with China is kinda of like the guy who borrowed so much from the bank, he thought he owned it. He did not, but he had a lot of juice on terms.

    I see massive fiat money flow into commodities etc, all stoking inflation, but I fail, both domestically and internationally, to see an increase in purchasing power of true end user consumers. Wage growth is not growing dramatically, it is even lowering in many areas. The Bernakes helicopter has not got to me, indeed I figure (now 54) by the time I get SS it will be reduced at least 1/4, or when I get it delayed. I think a great deal of the wealth generated by our printing could just go into the deficit hole of pensions and govt and private debt. 24% of homes are underwater. Payroll tax is not growing. Savings are minimal. Govt non tax revenues, fees and fines are growing. Intrest rates are rising as many countries consider controling inflation, (think food prices to feed the people) far more important then supporting the stock market. Bullish expectations have reached extremes. According to the Investment Company Institute, mutual fund cash levels are down to 3.5 percent. They got that low only once, in early 2010, shortly before the flash crash of May 6, which started a 20 percent correction and got the Bernanke to announce QE2.

    In short, how much of the created wealth goes into black holes and can even modest inflaton at this point crash demand for all but necessary necessities, and if people can not get those by purchase, will they either produce or take by force those necessary items? Prices can not go up much more if people have no means of purchasing and much of the demand is speculation driven beyond what true end users can pay.

    I think,????

  13. Chinese do not think like us occidentals use to, my hunch is that in some point they will make sudden and drastic changes, the best opportunity to justify those changes will be their next goverment change (next November?).
    Remember the chinese saying:”Wait at your door step and you will see the corpse of your enemy passing by”
    Anyone surviving the next 10 years will witness a totally different world.

  14. So….responsible countries should abandon monoculture practices and will have to increase food crops.

  15. Tim Clark says:

    They won’t drop the dollar. They will most likely go with a basket of all ‘major’ currencies. The basis of a new World-Unit of currency. One Universal Note, call it the UN for short.

    We already have it. It’s called Special Drawing Rights, or SDR’s.

  16. E.M.Smith says:

    @R. de Haan:

    Propane here is somewhat sporadic. It can be excessivly expensive at places like Yosemite where it’s sold mostly to campers by the 20 lb worth. It can be fairly cheap near refiners in places like Texas. Usually priced a bit below gasoline in places with large supply.

    CNG is cheaper at the moment at about 1/2 gasoline price (maybe 1/3 now that gas is spiking?)

    They are both great solutions, but the mandate to take the system apart and get the tanks tested every few years is a PITA.

    @David:

    For some reason I don’t ken, people all over the world like to think that some random group of other people who have a power lust will treat them better than they would treat themselves.

    Yes, it’s a risk. But they do want to throw off the tyrant and start down the road to freedom. That’s the first step. If they get detoured into another pen, well, that’s their choice then…

    FWIW, I think you will find it useful to make a distinction that I make between “wealth” and “money” and “currency”. You have used “wealth” in a way that implies you mean “currency”. To me, real “wealth” is actual goods and services that improve the quality of life. Things like rice, beans, cars, oil, gold, houses, roads. This excludes things like removal of a ‘bad’ as there is no new wealth created, but only an undoing of a prior screw-up. So things like “cash for clunkers” is NOT an addition to “wealth”, it’s just handing people pieces of paper to destroy cars (actual ‘wealth’). Now someone DOES go out an buy a new car, and to that extent someone DOES get more pretty pieces of paper in the process, but simply making that new car would have been wealth creation; with our without the wealth destruction of destroying the old one. That the wealth destruction FORCES someone into the markeplace so someone else can win the re-distributive process is NOT a net add to wealth…

    With that in mind, a lot more things fall into place.

    “Currency” is just a medium of exchange. It is not a thing of real value, and can never actually be “wealth” (with the possible exception of burning a bale of it to keep warm if trapped in a freezing vault ;-) So the Government can not ‘create wealth’ by printing currency. It can only ‘redistribute’ the existing wealth by handing that paper to folks who use it to echange for real value (wealth) with someone else (and the printing process reduces the ability of all other holders of pretty pieces of paper to do the same… so no net wealth creation, just a redistribution).

    So instead of: “I think a great deal of the wealth generated by our printing could just go into the deficit hole of pensions and govt and private debt.” recast it as:

    “I think a great deal of the wealth redistribution generated by our printing could just go into the deficit hole of pensions and govt and private debt.”

    And the game becomes clear. The printing press is used to move purchasing power from folks who hold currency to the folks with the printing press, who then hand it out as SS payments and bond payments… (the “deficit hole”).

    That is what I mean when I say “We will inflate away the deficit and pay back every nominal dollar”.

    Once you start to see “wealth” (creation, distribution, destruction) as distinct from “currency” a lot of things make more sense…

    BTW, “money” as the feature of “means of exchange” but also has “store of value”. So things like gold and silver have some inherent worth. That makes them a pretty good store of value (modulo central banks loons buying or selling hundred ton lots of it…) A paper currency may, or may not, be an effective store of value. It all depends on how trusted the central bank is in the duty to preserve the value. When the US Dollar was ‘gold backed’ it was money. Now, inflated down to about 4% of that original value and with the prospects of dropping like a stone in the future, it is clearly not “money” as it is not a ‘store of value’….

    So what IS a store of value today? Metals. Oil. Grains. “Stuff”… but not very good ‘means of exchange’. So I’d keep my ‘wealth’ in those ‘stores of value’ and only convert some of it to ‘currency’ as needed… FWIW, land will eventually return to it’s role as a store of value too, but only after the Sovereign Risk of government meddling is reduced….

    On my “someday list” is to create a “Net National Wealth” index that uses wealth as the metric. So a “cash for clunkers” or a ‘clean up an oil spill’ would be seen as the real net reductions is national wealth that they are. Yes, the oil clean up crews get some currency redistributed to them, but it came OUT OF the pockets of the shareholders and taxpayers. Oil was lost, not gained. Dispersants were thrown into the sea, not created. And people “stopped a bad” they did not “make a good”. The two are NOT fungible… (You can not fill bellies by stopping oil spills, only by growing food. You can not drive a car on oil ‘cleaned up’. Yes, cleaning up the spill is a ‘good thing’, so it is a “goods and services” and belongs in GDP… but it is NOT an addition to Net National Wealth… breaking windows to fix them does not create wealth, it destroys it.)

    Sidebar: On one of the history shows, IIRC it was about England, they had an interview with the child of the guy who had promoted a “turn in your pots and pans to defeat Hitler” program. The ‘thesis’ was that they needed the metal to make guns and planes. She shared that then program was all just a great ‘motivational effort’ and that they really didn’t know what to do with all the pots and pans. That, IMHO, is a great example of stupid politics vs ‘wealth’. The net national wealth was dramtically reduced by melting down all those pots and pans, and little was made of it. But folks ‘felt more involved’… You can never destroy enough wealth to make things better…

    Per markets:

    We’re having a profit binge right now. Don’t know how long the party will last, but companies have pushed things to the limit (as they do every recession) and are showing margin gains. The problem, as you pointed out, is that a lot of folks have no money left to spend.

    We’re “on the cusp”. If companies start to hire, the virtuous cycle begins. If government takes a larger cut of the pie and companies don’t hire, we’re headed into a double dip recession. (Some folks forget that the ’29 crash was followed by the ’32 depression… in between were a couple of good years…) So yes, we need to be especially vigilant now to ‘get out’ if things start to roll over.

    It’s all riding on Uncle Ben and his Magic Helicopter now…

    @Adolfo:

    I’ve had several Chinese and Japanese friends. There thinking is not all that different from ours. (Then again, California has had a long history of cultural influence by the oriental population here, so maybe it’s me who thinks more like them… Mu?)

    IMHO, NO responsible country should be ‘monoculture’. Yes, they ought to have some degree of farming for export. (Farming does have some significant economies of scale to it.) But I’d spread it over a dozen different main cash crops. In addition, I strongly believe that every country ought to have an indiginous row crop farming of traditional foods that are well adapted to the local land and climate. The 1000 kinds of potato in Peru, for example, or the 1000 kinds of corn in Mexico. Places like California (where you can get the chilling needed AND the warmth to ripen) are ideal for things like stone fruits (peaches, apricots, cherries, etc.) so ought to grow a lot of them for export; but their ought to be a large grow of things like “mediterranean” crops that are suited to the cold wet winter cycle. (Brusselsprouts, cabbages, beets).

    Unfortunately, The Powers That Be don’t agree with me.

    So we get vast oceans of corn and soybeans from Denver to Pennsylvania… with California and Florida growing almost all the row crops for the nation. (Though recently a lot of THAT has moved on down to Mexico… thus the Frozen Tomato problem from the Mexican freeze…)

    It seems to be what folks want.

    When I was a kid, we had ‘seasonal vegetables’ on the menu in the family restaurant. You ate what was harvested then. Squash in fall, peas in spring. (We also had canned vegetables for year round use). Now it’s pretty much “open the can” or “defrost the package” world wide. Is it really all THAT hard to not eat strawberries in December? Or peas in August? Apparently so…

    FWIW, as fuel prices rise, I expect to see more ‘seasonal vegetables’ and more ‘locally grown’ too. Lets just hope we don’t have to resort to “Liberty Gardens”…

    At any rate, yes, I know it’s blaspheme to say that a country ought to strive for food security ( and it sounds like something a Communist Dictator would say…). But I think it true. Maybe not ALL food, but enough to live through an emergency. IFF for example a rock fall from space puts a 200 foot tall wave on the ocean and sinks all the bulk carriers in the Pacific. Does your country die during the 4 to 5 years it will take to replace them? Some day that rock WILL fall… I’d rather live in a country that could say “On that day, we have Meatless Monday and Friday, and everyone gets beans and rice, no wheat or barley, but we live.” considering the alternative…

    No, it is not the most economical solution and no, market forces will not put you there. But markets are not perfect (only very very good) and sometimes they need a little help…

    So maybe you grow beans and rice in excess for export and import corn and wheat. At least “after the rock fall” you have beans and rice to eat… But if all you grow is cotton…

  17. KevinM says:

    “China will end up with needing to “accept” that it will have a monopoly position on things like socks and toasters and we will just need to pay a higher price for them.”

    They built their monopoly on cheap production.

    When cheap goes away, monopoly goes away.

    What to do with their US trillions?
    Buy US farm land.
    30 year lease on the Panama Canal.
    Pay their own population in Dollars.

  18. E.M.Smith says:

    @KevinM;

    There is hysteresis in the movement of production. You need ‘very cheap’ to get it all to move in, but it doesn’t move out when it becomes “somewhat cheap” or even “mediocre”. It only moves out when somewhere ELSE becomes “very cheap” in comparison. That will not happen in my lifetime…

    China could double what it pays it’s people and still not lose the monopoly position. For example, socks. They have a city which is built out to produce 100% of world demand. Just who is going to be able to compete with that economy of scale? Even if Chinese prices doubled. Nobody with a brain would go up against the Chinese government in that game of monopoly chicken. One year of predatory pricing and you are toast.

    They don’t need to pay their population in dollars. It’s easier to just print Yuan (and under their control… communist governments tend to be control freaks…) not to mention the “loss of face” of using US currency internally.

    They are much smarter than that. They will buy farm land (but it looks like they are going after Africa and South America instead of the USA) and they will buy mines and ships and coal and… Why would a good central planner give power to the people with US dollars when he could use it himself to buy, for example, Brazillian oil? (Which they have already done to the tune of $200 Billion…)

    They have also attempted to buy some major US industries (and succeded at a few). So watch for them to buy up industries globally. All good monopolists buy out the competition prior to a price hike. They are also going for vertical integration. So watch for things like cotton mills in other lands. Then the cotton land itself.

    Basically, it doesn’t matter HOW you built your monopoly once you have it. “Monopoly power” lets you hang onto that position much more easily than a newby can break in. That we were stupid and didn’t bother to hang on to our industries (in fact, encouraged our industries to bail…) does not mean China is that dumb. Or that committed to ‘free markets’ and ‘anti-monopoly policy’…

    Give me a monopoly on production of lightbulbs or oil or even socks, and no anti-monopoly legal entanglements, and I can hang onto it forever… That’s WHY we have anti-trust laws in the USA. Standard Oil, in particular, was notorius for opening a gas station accross the street from an established one and selling gas at ruinous prices until you were driven out of business, then jacking up the price and moving to the next city. NO ONE would put a station up in competition to them in the ‘old towns’ as they knew that Standard would just ruin them with below cost gasoline; and anyone dumb enough to try did get ruined.

    So don’t expect “competition” to keep China in line. Communism is based on the notion of one central monopolist setting policies and doing the planing. (As, BTW, was the Fascist form of Socialism…)

  19. R. de Haan says:

    Day Of Rage: Americans Finally Reacting To Economic Rape?
    No budget cuts, public sector pension contributions, or any austerity measures whatsoever can redress the $1.4 Quadrillion dollar derivatives debt tsunami that Americans will now have to face as a result of the financial terrorists unleashing what promises to turn into an inflationary holocaust.
    As the Economic Edge blog points out, “The global size of the derivatives bubble which was calculated last year at USD 190k per person-on-planet, has risen to USD 206k per person-on-planet. The ever rising commitment of governments for the repeated bailouts of financial institutions is partially linked to various flavours of derivatives exposure settlements and “black hole” losses emanating from off-balance-sheet vehicles.”
    Indeed, the entire GDP of every single country in the world only amounts to around $60 trillion. How can we ever hope to pay off $1,400 trillion dollars?
    We can’t and we won’t. The only way that this $1.4 Quadrillion mountain of debt will disappear is a total and complete collapse of the global economy and its replacement with a new financial system.
    Whether that also simultaneously brings down the US dollar and the United States itself as a first world country remains to be seen, but anyone who believes that a few years of austerity can redress the balance is living in cloud cuckoo land.
    Once the whole charade starts to unravel, the scenes we saw in Cairo over the last few weeks will look like a walk in the park in comparison to the turmoil that awaits as a result of the derivatives bubble.
    RELATED: IT’S THE DERIVATIVES, STUPID! WHY FANNIE, FREDDIE AND AIG ALL HAD TO BE BAILED OUT
    http://www.prisonplanet.com/day-of-rage-americans-finally-reacting-to-economic-rape.html

  20. George says:

    It only moves out when somewhere ELSE becomes “very cheap” in comparison. That will not happen in my lifetime…

    It already is happening in some industries. Textiles, for example, are leaving China and headed for places like Cambodia and Burma. That is usually the first industry to move because it is the one that is labor intensive and lowest margin. People don’t want to pay much for a t-shirt or a pair of socks.

    The company I work for decided not to expand our China operations and opened an office in an Eastern European country instead.

    The problem with China is that it is not yet its own biggest customer. Once that happens, look out. A nation runs a trade surplus that produces more plastic poop than its people can purchase. Once the people become affluent enough to purchase as much as they produce in a year, the trade surplus China runs with the rest of the world will be gone.

  21. LarryOldtimer says:

    Unfortunately, often in history many battles have been won by nations which, in the end, lost the war.

    Famine can be caused by prices so high that the masses can’t afford them, which is exactly what is occurring in the Mideast as of now. Changing governments is not going to have any positive effect.

    Take a look at what is happening in the state of Wisconsin as of now. Taxpayers can’t pay the exorbitant salaries and benefits of government employees, and government employees can’t weather the cuts in take-home pay without going bankrupt.

    A seething anger has been building up here, in our own nation. This does not bode well for citizens of the US.

  22. E.M.Smith says:

    @R de Haan:

    I’d be careful about getting too wound up about the total size of the derivatives markets. This ignores that many of the contracts are offsetting. So, for example, I may have a “long wheat” and “short barley” contracts. That doesn’t mean I need to come up with $200,000 each. One offsets the other as a long / short pair. Or for mortgages, do we really think everyone will ever have all mortgages paid off at the same time? And if one bank is “long a mortgage” and another is “short a swap” against it, it’s not really valid to just add them together. Then if they both have some insurance on those loans ( “credit default swap” or CDS) that, too, is not really additive. There is only one real debt instrument to “pay off”. The insurance parts only ‘kick in’ if the mortgage defaults (and then only one of them would ‘pay out’ as they are insurance on opposite sides of the bet…)

    So, for example, Bank A may have $1 Billion in loans to Bank B (and “CDS” contracts on them) while Bank B may have $1.1 Billion in loans to Bank A (with their CDS’s). You could tote that all up and say “OMG, who’s going to come up with $4.2 Billion Dollars?”… but the reality is that there is really only $200,000 of net debt left to cover if they both defaulted.

    @LarryOldtimer:

    Yup. Trying to get sympathy from the folks serving Taco Bell at minimum wage is going to be a bit hard for the folks on the Golden Government Gravy Train.

    Frankly, I look at the costs of going back to work in California and think “Maybe I’ll just stay home a bit longer… it’s cheaper.” It is hillarious to watch Gov. Moonbeam flop around trying to find a way to “fix it”. He can’t piss off his “base”, won’t can the unions and government pay scale, and it’s impossible to bring in new business until he does. At least the Governator realized it was hopeless and just shut down for the last few years. ;-)

    BTW, one of the ‘signatures’ of a Grand Minimum has generally been revolutions and social disorder…

  23. R. de Haan says:

    E.M. Smith,

    I am familiar with the principles and use of the CDS’s and the derivatives.

    The problematic point lies with the fact that nobody knows who has the potential cat in the bag.

    And if you talk insurance here we are over insured don’t you think so?

    If our global GDP is 60 trillion and we have 1400 trillion in derivatives and CDS’s floating above the market, this is quite an overkill of more than 23 times the Global GDP? Really, I could live with 2 times the Global GDP but 23 times simply is outrageous and because of the fact that many of those are purchased over the counter make them a great risk because you don’t find them in the official books of banks, institutions and companies.

    The only reason our Governments bailed out the banks and insurance companies was because the alternative to their bankruptcy was even darker as Governments back up their National Banks.

    Thanks to the CDS and the Derivative market speculating on the defaulting of entire countries, international corporations, cities, communities, baks and insurance companies they have us all by the balls forcing us to bleed for generations. Am I right or am I right?

    You only have to think what happened to the Apple shares last week that suddenly dropped losing billions.
    This was triggered by a pollution problem with the China based manufacturing plant of Apple.

    Do you think that this fluctuation would have taken place if the company was not covered by CDS’s and derivatives from top to bottom?

    No, playing, or better said, fooling around with these tools make companies, individuals and banks more money than doing clean honest business.
    For some this is free money, for others it means stagnation, growing unemployment and a gliding slope into poverty.

  24. E.M.Smith says:

    I agree that the derivatives tail is now wagging the dog.

    I just don’t agree that it means doom for the world.

    At most we would just scrap the currency and start over. It happens every generation or so somewhere or other in the world. PITA and a bunch of suffering, but hey, “stuff” happens.

    The issue is called “Moral Hazard”. If you bail out Goldman they expect to be bailed out in the future, so bet more aggressively.

    The “cure” is to start taking firms out and shooting them. They did that with Lehman and Bear Stearns. Then got scared. They need to just start taking one every couple of months or so and shooting them in the public square:

    Notice: Goldman has been found to have issued more CDS contracts than it can cover. The assets will be liquidated next month and the contracts will be wound down….

    The basic problem is that anyone can issues a CDS “insurance contract” but is not governed by the rules and reserve requirements of insurance companies.

    The ‘easy fix’ would be to just pass legislation that all future CDS (and similar or related insurance like contracts) could only be issued by licensed insurance companies subject to standard insurance laws and paractices.

    Wait 6 month… then start the public executions of any company not in compliance…

    But it will never happen. Goldman is in the henhouse..

Comments are closed.