Fixing Interest Rates?

[agrippa1]

China continues to purchase U.S. debt at low interest rates, even though they know we will likely monetize our debt.

China wants gold, is purchasing tonnes of it, and is making noises about introducing a gold-backed currency for international finance.

U.S. has tonnes of gold reserves, which are not really reserves anymore, since all of the value of our currency is tied to future production, and not to any commodity.

So, are our leaders too honest to offer kickbacks to the Chinese for U.S debt, in effect raising the interest rate we pay them, in the form of untraceable gold, which was stolen from the holders of U.S. currency when FDR outlawed private ownership?

[Grames]

Does this movie have a release date?

[softwareNerd]

We could bribe them with some other commodity... tin, perhaps?

[gags]

The prospect of the Chinese introducing a gold-backed currency seems remote to me. Fiat currencies allow for so much more "flexibility" (i.e. potential for manipulation) than would a currency backed by a tangible-asset. I doubt a government like the communist Chinese would want to tie their hands. Besides, our government is doing a fine job of wrecking the dollar without much help from the Chinese. At this point, they can just sit back and watch.

[sanjavalen]

I do not believe the Chinese have any interest in "wrecking" the dollar, since so much of their own reserves are based on the US Dollar. If that tanks, so does their rather extensive treasury. Right now they (and many other foreign govts) continue to buy our debt based on two facts:

1) The US does not look like it will default on its debt yet

2) If the loans stop, the US will definitely default on its debt

Putting them in somewhat of a bind. My personal, nonexpert opinion is that they are just hoping "something" happens so that the US' current unsustainable deficeit spending becomes sustainable, "somehow." In the meantime they are doing their best to delay the inevitable.

[softwareNerd]

The Chinese say that have started adding to their gold reserves. If one believes their numbers, about a month ago, their central bank raised its gold holdings from 19 million ounces, to 34 million ounces. That is an addition of $15 billion worth of gold at today's prices. While that seems like a lot, they also claim to hold foreign currency reserves of about $2000 billion. During 2008, the Chinese claim to have accumulated over $350 billion of new foreign-exchange reserves, so starting to put some more of it in gold makes sense. Given the large numbers here, the additional $15 billion seems tiny. If I were a Chinese commie-boss, I would want to raise that as much as I could. Why hold dollars and have to rely on the U.S. government, when one can hold gold?

The answer to that question is: holding dollars helps support the value of the dollar, which the Chinese have seen as being in their interest. This comes from a mercantilist view coupled with some legitimate reasons why countries like China find it easier to boom by stressing exports. After our current financial crisis, the Chinese must realize that they need to enter a new phase, where they turn their economy to being less reliant on the U.S. They're still left with two problems. First, a transition can take some years. Second, they hold a lot of their foreign-reserves in the form of U.S. government and agency securities, which will fall in price if U.S. interest rates rise.

So, the question they face is this: how to transition both the economy and their portfolio? They can do it, if the U.S. is willing to play along with the transition. If the U.S. curbs its Federal deficits, it protects the value of the U.S. dollar over the long run. As the Chinese slowly ease their support of the dollar, they want the U.S. government to start to support it with more than words. What leverage do they have though? Not much, except playing a game of chicken. They can threaten to remove their U.S. dollar support unless they see signs that the U.S. is doing more. It will hurt them, but the message is: "if you think you're going to hurt, we'll show you what real pain feels like, and we'll show you that our population will endure more pain than your electorate can." That is probably the reason they're sending out mixed messages: one high-level official says they might consider a commodity-based currency, while another says the dollar is the only game in town for now. That is why they have started to diversify their foreign-exchange holdings (for instance, their was a recent report that they wanted to deal with Brazil, reducing the use of the US$ as an intermediary currency). That is why the Treasury Secy. was in China last week, promising them that the U.S. would keep its Federal deficit to within 3% of GDP.

If the Chinese can apply such pressure on the U.S. government, I say: more power to them, in this regard.

I think almost every player in this saga assumes that if the U.S. default it will be via the process of inflation, so that it is not defaulting in legal, technical terms. If the U.S. defaults by actually saying they will only pay a certain number of cents on government debt, that creates a whole new picture. It will undermine the ability of the U.S. government to borrow, for quite a few years. I doubt Obama will even consider the prospect of a real default.

[sanjavalen]

Softwarenerd, wouldn't the effect of defaulting-via-inflation also undermine the ability of the US government to borrow for quite a few years?

No one wants to borrow from a guy who will pay them back in monopoly money, even if its technically not breaking the contract, no?

[DragonMaci]

Shouldn't this thread be in the Economics sub-forum?

Softwarenerd, wouldn't the effect of defaulting-via-inflation also undermine the ability of the US government to borrow for quite a few years?

No one wants to borrow from a guy who will pay them back in monopoly money, even if its technically not breaking the contract, no?

I know your were asking softwareNerd, but that is the way I see it.