« China could soon stop propping up the dollar as it worries about its own economy.

China Can’t Afford More U.S. Debt

January 8, 2009 | From

America’s consumer-based economy is predicated on Chinese lending. Now China can’t lend like it used to.

China can no longer afford its massive lending to the United States, the International Herald Tribune has reported. China has already spent $1 trillion on American debt. In the past five years, Beijing has used as much as one seventh of the country’s entire economic output to buy up foreign debt—principally U.S. treasury bonds and mortgage-backed securities.

But China now has too many problems of its own to worry about the U.S. The Chinese government is planning a $600 billion stimulus package for its own economy, leaving less cash to stimulate America’s flagging economy. Chinese tax revenue has fallen sharply, so instead of spending Chinese cash on America’s debt, Beijing is trying to finance its own recovery.

In the past, China’s readiness to buy debt has kept an otherwise-sinking U.S. economy afloat. Now that flotation device is disappearing right when America needs it most. The Tribune writes, “In the United States, China’s voracious demand for American bonds has helped keep interest rates low for borrowers ranging from the government to home buyers. Reduced Chinese enthusiasm for buying those bonds takes away some of this dampening effect” (January 8).

“All the key drivers of China’s treasury purchases are disappearing,” Ben Simpfendorfer, an economist in Hong Kong, said. “There’s a waning appetite for dollars and a waning appetite for treasuries. And that complicates the outlook for interest rates” (ibid.).

The Tribune goes on to detail exactly why China is now unable to lend to the U.S. like it used to. China has bankrolled its huge reserves by effectively requiring its entire banking sector, which is state-controlled, to hand nearly one fifth of its deposits over to the central bank. The central bank, in turn, has used this money to buy foreign bonds.

Now the central bank is rapidly reducing this requirement, instead pushing banks to lend more money domestically.

At the same time, three new trends mean fewer dollars are pouring into China to begin with. As fewer dollars flow into China, the government has fewer dollars to buy American bonds and help finance the U.S. trade and budget deficits. The Tribune reports:

* The first little-noticed trend is this: The monthly pace of foreign direct investment in China has fallen by more than a third since the summer. Multinational companies are hoarding their cash and cutting back on factory construction.

* The second trend is that many overseas investors—and some Chinese—are quietly pulling their money out of China. The reason: a combination of a housing bust and a two-thirds fall in mainland Chinese stock markets over the past year. Investors are pulling out in spite of China’s fairly stringent currency controls, prompting the director of the State Administration of Foreign Exchange, Hu Xiaolian, to warn on Tuesday that “abnormal” capital flows were taking place across China’s borders. She provided no statistics.

* A third trend that may further slow the flow of dollars into China is the reduction of its huge trade surpluses. China’s trade surplus set another record in November: $40.1 billion. But because prices of Chinese imports like oil are starting to recover while demand remains weak for Chinese exports like consumer electronics, most economists expect China to run trade surpluses closer to $30 billion a month.

This Chinese cash crunch comes at the same time the U.S. wants to borrow large amounts of cash in an attempt to borrow its way out of a borrowing-and-greed-induced recession. U.S. politicians have announced plans to spend trillions of dollars. If the money doesn’t come from China and other foreign lenders, the U.S. will have to create it from nothing. Common sense—not to mention history—should tell us that a nation cannot become richer by simply printing more money.

The fact is, the Great Recession is here, and America’s patched-up, jury-rigged economy is simply out of options. Built on a faulty foundation, it has to fall. No ad hoc repairs can fix it permanently. Because they ignore altogether the foundational failures of our economy, these “solutions” simply prolong the agony.

For more information on the economic problems facing the U.S., read “The U.S. Recession and the Zimbabwe Option.”

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