The Moving Picture

China has apparently "threatened" to diversify its $1.4 trillion stake in U.S. Treasury securities, another in a series of financial body blows offered to explain the 1,000 point fall of the Dow Jones over the last few weeks. Our Commie loan-shark friends only increased their Treasury stake about $13 billion last fiscal year, which was worrying enough. Uncle Sam needs to sell about a quarter trillion of IOU's during the course of a year in order to "balance" the books, or about $20 billion a month. During the seven years of the Bush Administration, this has been accomplished almost entirely by sales to foreign nations and Caribbean "banking centers." The U.S. Treasury pays such a piss-poor return on its debt that only nations with geopolitical aims bother to buy the stuff. China's goal, of course, has been to prop up the American consumer by flooding the Treasury with recycled greenbacks which can be loaned out to cash-strapped Americans through re-fi and lines of credit. They have tolerated the double whammy of a low interest rate and a devaluing dollar (which, acting in tandem, mean that the principal investment of China in America actually loses money in real terms) because of the favorable balance of trade with the U.S. (to say the least).

It's possible that China's veiled "threat" was a shot across Ben Bernanke's bow. The harried Fed Chairman is, like his predecessor, a one-trick pony. When the American economy is flagging, he lowers the interest rate to pump cash into the "consumer" economy. Last time he trotted his little horse around the ring, the dollar sank again and increased Commie losses. The Chinese are letting Ben know that another rate cut (which only provided a temporary boost anyway) might trigger a switch to more stable currencies, such as the Euro. This state of affairs puts Bernanke, and the Bush Administration in general, into a delicate quandary. Bernanke cannot very well explain the real reason he can't do the one thing he knows how to do. If he did that, even the comatose press might think of a tricky question for Bush: was it a good idea to give a bunch of Commies the power to dictate U.S. financial policy? A lot of happy talk about the "flat earth" and the "global economy" isn't going to placate the jingoistic Nascar crowd. It's just better if a subject like that doesn't come up. Yet if Bernanke doesn't lower the rate, the machers on Wall Street who are dying from the liquidity drought are going to scream bloody murder.

When you have arrived at the point where there are no good options, you can reliably guess that the mastodon shit is about to make contact with the helicopter tail rotor. Bernanke can't use the rate panacea without risking a sell-off of the huge Chinese position, which is roughly equal to half the yearly federal budget. Treasury Secretary Paulson will have to find buyers for all that debt to avoid a catastrophic default, which means he will have to increase the interest rate paid, which means raising the Fed rate, which means bringing the moribund American economy into full cardiac arrest.

I notice that the main presidential candidates do not discuss these issues in these terms. The general approach is to talk about "fiscal discipline" with vague references to the trade imbalance and the national debt. The Democratic candidates are making hay with Bernanke's acknowledgment of a slowing economy, and even the possibility of a recession, or two consecutive quarters of negative GDP growth. However, since the candidates are required, in the main, to be upbeat and respectful of the mighty American economy, talk of dire scenarios is off limits, with the possible exception of the token mavericks, Ron Paul and Dennis Kucinich. However, the very fact that reality is only discussed by the marginal candidates tends to reinforce the idea that they are talking speculative doomsday strictly to attract attention, and that if they were "serious" candidates, they would fall in line with the business-as-usual approach of the leaders.

The drastic slowdown in the re-fi and housing markets is a leading indicator that about half the "income" previously in the economy (according to figures quoted by Kevin Phillips in "American Theocracy") is in the process of evaporation. If the U.S. economy is 70% consumption-driven, which it is, then a first approximation based on simple math would suggest that the economy could contract by 35% in the absence of equity funding. This would tend to add impetus to the Chinese inclination to diversify its oversea investments; Chinese interest in the United States is limited to the ability of the American consumer to buy Chinese imports. In turn, this would leave the U.S. Treasury in a dangerous position. Add to these factors the prospect of $4 per gallon gasoline and rising food prices, and the happy talk and irrelevant posturing about "homeland security" seem bizarrely off topic.

I think this is a further instance of the subject discussed in the last post. It has become impossible, in the political sphere, to discuss real problems in empirical terms. Since these huge problems cannot be addressed honestly, they simply gather force and become less susceptible to solutions. Much of the complacency about this central dilemma of American insolvency is based upon a perception that the United States is the cornerstone of world commerce and therefore the other advanced nations cannot afford to see America founder. I think this is true as a temporary snapshot of geopolitics; the problem is that history is a moving picture. We're not adapting to rapid changes in a timely way (although in theory we could, with enlightened leadership), and American's leading-man role, like an aging star of stage and screen, is giving way to hot new actors from foreign countries.