Chester ---

Good post about China's possible future, and one that is worth some sober thought. I'll toss a few ideas into that pot...

First, some few years back there were a handful of contrarian economic pundits, who cautioned that China's economic success was very much a house of cards, and that it relied upon financial arrangements that were (at best) non-transparent, or possibly (at worst) patently fraudlent. Such arrangements can be kept going for quite a long time in an expanding economy, but if that economy ever stumbles, all falls apart. In other words, it's like a great big Ponzi scheme. Nobody seems to talk much about this these days, but I haven't seen much to indicate that anything substantial has been done to correct the underlying problem.

Second, when Asian economies have gone through some serious readjustments, a very typical response by the affected governmental leaders was to blame the West, including the world financial organizations (e.g. the World Bank), western political leaders, opportunistic currency speculators, and so on. Basicly, to divert blame instead of directly addressing the issues that really needed to be fixed. I don't see China as doing anything different, and would expect her to externalize blame in direct proportion to the magnitude of any financial crisis.

And finally, China's leaders have some tradition of being quite ruthless pragmatists. Unlike western leaders, I see the Chinese as believers that their society can survive virtually any conflict with the outside world. It is entirely too likely that during a severe economic crisis, in order to reinforce nationalistic support for the government, that they would engage in some kind of external military adventures, even knowing that they would eventually be defeated on the battlefield (Taiwan, specifically, comes to mind here).

It is all a very dangerous and volatile mix, and I worry that too few folks are paying proper attention to it.

Just my $.02

DRK

I half agree with you. I am not prepared to predict doom and gloom for China's economy, yet, at the same time, I too find it ridiculous how predictions on China's future nearly always show a line going straight up.

China Law

I think you're spot on... a friend who is a money manager with Firm Unnamed, Location Unknown tells me all the time he thinks that when the China bust comes, it's going to be a whopper.

And the aftermath of the whopper is indeed reason for some sweating...although I'm sure Taiwan and Japan are probably sweating worse than we are. Given the oil and resource picture there, perhaps we need to sweat a bit more.

I have said for a long time that I wish we would make some effort to draw Moscow into more friendly relations, as a hedge against problems in Asia. (We did ourselves no favors, and the Euros too many, by getting so involved in the Orange Revolution thing in Ukraine). But that's a subject for another time. Great post.

A good analysis. A couple of points:

1) As DRK said, the terms "Chinese Economy", and "Transparency" are never uttered to gether. This whole economic boom has been built on virtually free labor from China's (almost inexhaustible) supply of rural citizens moving to the cities, the willing Western inducstries investing in infrastructure there, and the utter lack of any real banking or financial transparency. There's no accountability when the government owns or is the majority partner in so many enterprises.

2) All this is also being propped up by the flows of dollars to China as they soak up our federal debt. Now, while the argument can be made that we have more trees than they have dollars, we are rapidly becoming indebted to China to an extent that we will be their serfs. If the economy busts over there, AND IT WILL, who's going to buy all our debt when they dump it on the world's financial markets. If they go, they can take us down with them.

I was just musing today about how Iwould change my "lifestyle" if gasoline doubled in price from what it is now. For me, a retiree who doesn't drive much, it probably won't mean much. For my children who must drive 40+ miles per day roundtrip to work, it will probably become a major part of their budget... right up there with food, insurance, mortgage, and taxes if it isn't already! Since the salaries are not increasing proportionally, this probably means that some of the "nice-to-have" items will NOT be bought. When I did a quick inventory around here, I found many of these items had "made in China" somewhere on them! Increased fuel prices also will mean increased transport costs from China. All this means bad news for China's economy, IMHO.

Has a Communist society ever had a "Depression" or "Recession". I ask this seriously, as it occurs to me that Communist societies, even China's, may not recognize or understand the terms. In fact, they probably think such things are unique, bad consequences of Capitalism. It may be a completely foreign term to a "planned" society!

Zarba,

As to your second point, I am not a bond trader, but it strikes me that people will buy anything if it is priced cheaply enough. If Chinese institutions have to liquidate their US Treasury holdings, the result will probably be a temporary drop in price in T-notes. But since those are backed by the full faith and credit of the US government, people will snap them up at bargain prices. I'm not an economist, and can only envision first order effects, and little beyond that, but Chinese dumping our T-bills doesn't bother me too much. It would be like anyone else who has to liquidate an investment because they need cash. It doesn't indicate any revaluation of the underlying value of the asset supporting the investment. It just reflects a temporary cash crunch on the part of the investor . . . I could own millions of shares of Google and need to sell them to pay my bookie. It might make the price drop a bit when I dump the shares, but the underlying value of Google won't have changed and someone will buy them for a bargain.

Also, as far as Chinese individuals go, I think many individuals invest in US government securities because they are the most predictable, most stable, least risky investment in the world. A good friend in Japan has a theory that the reason the coastal merchant class of Chinese saves 40% of every dollar they make is because they know historically that Chinese governments end up falling and they lose fortunes, or that the governments end up confiscating their fortunes somehow.

If I'm a successful businessman in Shanghai and know that governments in China have a history of confiscating fortunes, and, since I'm a successful businessman, I know that the economy has all kinds of things that can go wrong with it . . . I might just hold onto my T-bills because if all else fails, Uncle Sam will still pay me my 3-5% a year.

Nobody ever mentions this, but America is always categorized as a "young" country, or a young culture. But our government is one of the oldest in the world. I challenge anyone to find another regime that has lasted as long. Switzerland? The British constitutional monarchy? Seems like everywhere else, the regime falls and completely changes its nature every few decades . . .

The future of China is indeed a major concern. One issue I haven't seen discussed much is it's rapidly aging population.

Seems their draconian population control measures of the '70s and '80 worked a bit too well. In the next ten to fifteen years they will have a very old population, worse than our own "baby boom" issue.

Dr Thomas Barnett calls it the "four-two-one" problem. That is, they will have one person working to support two parents and four grandparents. It will cause many economic and social problems.

The other problem is the unbalance between the sex ratio that their population control measures brought about. Instead of the normal ratio of approximately 50/50, their ratio is closer to 60/40, boys to girls. This could also cause social and economic problems and a further inbalance in the age ratios as adult men are unable to find a mate and reproduce.

And I'm not even gonna mention all the sexual frustration these men will have and how they will act out on it!

China isn't going to have what we call a recession because they don't have what we'd call an economy.

They have a bunch of businesses that sell for export. They have an incredible export business, and most of what they sell isn't particularly available to their own citizens. They have a high savings rate partly because they don't have a lot of high-ticket items available to suck up their surplus cash.

Meanwhile their banks loan the money to people who want to start businesses. There isn't that much consumption. People whose parents were peasants are happy to work very long hours indoors, and save money. Compared with how their parents lived, it feels like a big step up.

They would be just as happy to work long hours in munitions plants.

China has lots of resources but they're coal-rich and oil-poor. So one thing that could hurt them is an oil shortage. If they can't get enough oil to expand production, then they have to stop expanding. They are buying up oil contracts all over and establishing long-term relationships with oil suppliers. When we try to overthrow nicaragua they step in to be the nicaraguan government's friend. When we talk about overthrowing iran they step in to be iran's friend. Etc. But a whole lot of the oil gets shipped by tankers and we control the blue water, we can blockade china easily (from a safe distance) and cut off their oil imports. If it comes to that. China is much more serious about alternate energy research than we are, and they're keeping their railroad system on coal. (But they have a lot of railroad bridges for our cruise missiles to hit. If it comes to that.)

There's no economic reason for them to face an oil shortage. They can pay. The renminbi is a very sound currency. The US dollar is not a sound currency. It doesn't depreciate all that much because the chinese are pegging it, they keep the dollar high and it costs them to do so. Chester mentions the "full faith and credit of the US government". This is pretty much gone. We have credit because the chinese government banks are extending us credit, and because they are propping up our money. It isn't completely clear to me why they are doing this. They sell us woven baskets and plastic flyswatters and computer components etc. We sell them lumber and construction supplies, particle board etc.

Suppose they were to cut the dollar loose, and only sell us enough to balance what they buy from us. The dollar would depreciate. Their money would buy more lumber than before. They could take the raw materials they used to use to make flyswatters and computer components and look for another buyer so those workers wouldn't sit idle. Chances are they could find one, but it wouldn't hurt them to have those guys make stuff for local sale. Or make munitions. Or do make-work and get paid. What they spend making stuff to sell to us for extra dollars they have no earthly use for, is wasted even more when they ship it to us than it would be if they piled it up in the gobi desert.

We're in a precarious state. We produce something like 40% of the oil we use. If we couldn't pay for as much as we need, our economy would implode. We don't have enough oil so the least profitable businesses shut down. More people out of work, which weakens domestic industries and the least profitable shut down. Companies that export for hard currency would be OK. Unless the government banned it, we could easily become an oil exporting nation -- exporting oil would bring in considerable hard currency.

Of course we might declare that our navy would confiscate half the tanker loads anybody sends anywhere, according to some fair schedule. Who could stop us? That would be a stopgap measure, though.

We think of the chinese banks as using our money as reserves. Their money is valuable because it's backed up with dollars. If they let our dollars turn to waste paper then they'd have a giant problem with all the US debts they'd have to write off. But that's only a problem if they make it a problem. Why can't they just keep right on lending for expansion? Their money is backed up by the full faith and credit of the chinese government. And while they're expanding and getting foreign investment, it looks like a good bet. Also, the more factories and patents and raw materials they buy, the more credible the renminbi gets for the reserve currency to replace the dollar....

We get recessions when we try to expand too fast and have to cut back. This happens when we run out of workers (and get wage inflation) or we run out of resources (and get stagflation) or we miscalculate (and then something breaks). China isn't going to run out of workers any time soon. And they'll have lots of jobs that old people can do, no particular reason for the grandparents to retire. They'll run out of resources if somebody else can outcompete them for those resources -- notably if we can militarily shut off their oil. Maybe they'll miscalculate, but they won't do that the same way we do because they don't make the same assumptions.

Posted by: J Thomas at April 22, 2006 11:15 PM

“China has lots of resources but they're coal-rich and oil-poor.”

Her drilling technology is so primitive no one can be so sure. What is plain is that outstanding drilling prospects off shore go untouched because China’s state industry can’t work them – cutting a deal with big oil: unthinkable.

Beyond that, China’s low labor costs make it already viable to retort coal liquids (1bbl
per ton) while cleaning up their nasty air pollution.

The world is out of cheap oil, not out of oil. At today’s prices coal, tar sands and ultra heavy Orinoco crude ( double the size of Saudi reserves ) are all economically viable sources of oil.

‘The renminbi is a very sound currency.”

It is a coupon currency in the manner of all Communist ‘monies’.

The reason for China’s boundless thirst for US debt is that such instruments are essential to collateralize her international trade. US financial instruments stand behind all of her imports. Absolutely no one wants the Renminbi

“The US dollar is not a sound currency.”

The US dollar is international money and is the benchmark for essentially all international trade and most internal trade within non-market economies. China, Russia and the rest may have notional national currencies but all of their significant internal trade is dollarized. That is, the trade was set in US dollars but executed in the national currency at term using the current rate of conversion on the dollar.

“It doesn't depreciate all that much because the chinese are pegging it, they keep the dollar high and it costs them to do so.”

So the whole relative value is fake and prone to snap collapse, something ultra common in international finance.

“Chester mentions the "full faith and credit of the US government". This is pretty much gone. We have credit because the chinese government banks are extending us credit, and because they are propping up our money.”

Their positive balance of trade with us is propping up their currency. The trading value is rigged to our consumer’s advantage because China has an overwhelming thirst for solid assets not subject to the whims of her dictators. That is why her citizens accumulate both gold and dollar assets at a frenetic pace.

“Suppose they were to cut the dollar loose, and only sell us enough to balance what they buy from us.”

Their economic growth would immediately choke down to zero: imports would be throttled. No net increase in letters of credit could be attained. They might as well as put a gun to their head.

“The dollar would depreciate.”

Their exports would rise in cost much to the delight of all other manufacturers. India and Mexico would give them a hat tip.

‘We're in a precarious state. We produce something like 40% of the oil we use.”

All of our significant rivals produce even lower levels of oil: India, China, Japan, and Europe. We catch cold, they have pneumonia. Of course, Canadian, Mexican, Venezuelan crudes are a strategic lock for us. Our imports from the Middle East are a minor fraction of demand.

“We think of the chinese banks as using our money as reserves. Their money is valuable because it's backed up with dollars.”

Bingo, except dollars are not reserves – they are collateral – the asset that backs up a flaky asset.

“Why can't they just keep right on lending for expansion?”

They have to keep on accumulating dollar assets to support letters of credit. NO ONE will accept the word of the Communist Chinese. They have no due process, no law.

“Their money is backed up by the full faith and credit of the chinese government.”

Which is zero, their money is backed up by US dollars – it’s collateralized. This is ultra common in the third world.

“Also, the more factories and patents and raw materials they buy, the more credible the renminbi gets for the reserve currency to replace the dollar....”

Absolutely no amount of economic activity can substitute for due process of law. You either have it or you don’t.

Japan got into deep trouble because she was totally geared as a momentum export machine.

China is in the exact same path and must hit the exact same wall. The only part of her economy that is cranking along is exports. Her ‘banking system’ is even flakier than Japan’s at the top of the bubble. Neither society can handle massive financial failure, resource re-allocation or bankruptcy through orderly court proceedings. Japan finessed her woes by kicking the can around the Kiritzu for ten years. I would expect China to have a major mental malfunction. One can only hope that they are not locked and loaded.

Posted by: J Thomas at April 22, 2006 11:15 PM

“China has lots of resources but they're coal-rich and oil-poor.”

Her drilling technology is so primitive no one can be so sure. What is plain is that outstanding drilling prospects off shore go untouched because China’s state industry can’t work them – cutting a deal with big oil: unthinkable.

Beyond that, China’s low labor costs make it already viable to retort coal liquids (1bbl
per ton) while cleaning up their nasty air pollution.

The world is out of cheap oil, not out of oil. At today’s prices coal, tar sands and ultra heavy Orinoco crude ( double the size of Saudi reserves ) are all economically viable sources of oil.

‘The renminbi is a very sound currency.”

It is a coupon currency in the manner of all Communist ‘monies’.

The reason for China’s boundless thirst for US debt is that such instruments are essential to collateralize her international trade. US financial instruments stand behind all of her imports. Absolutely no one wants the Renminbi

“The US dollar is not a sound currency.”

The US dollar is international money and is the benchmark for essentially all international trade and most internal trade within non-market economies. China, Russia and the rest may have notional national currencies but all of their significant internal trade is dollarized. That is, the trade was set in US dollars but executed in the national currency at term using the current rate of conversion on the dollar.

“It doesn't depreciate all that much because the chinese are pegging it, they keep the dollar high and it costs them to do so.”

So the whole relative value is fake and prone to snap collapse, something ultra common in international finance.

“Chester mentions the "full faith and credit of the US government". This is pretty much gone. We have credit because the chinese government banks are extending us credit, and because they are propping up our money.”

Their positive balance of trade with us is propping up their currency. The trading value is rigged to our consumer’s advantage because China has an overwhelming thirst for solid assets not subject to the whims of her dictators. That is why her citizens accumulate both gold and dollar assets at a frenetic pace.

“Suppose they were to cut the dollar loose, and only sell us enough to balance what they buy from us.”

Their economic growth would immediately choke down to zero: imports would be throttled. No net increase in letters of credit could be attained. They might as well as put a gun to their head.

“The dollar would depreciate.”

Their exports would rise in cost much to the delight of all other manufacturers. India and Mexico would give them a hat tip.

‘We're in a precarious state. We produce something like 40% of the oil we use.”

All of our significant rivals produce even lower levels of oil: India, China, Japan, and Europe. We catch cold, they have pneumonia. Of course, Canadian, Mexican, Venezuelan crudes are a strategic lock for us. Our imports from the Middle East are a minor fraction of demand.

“We think of the chinese banks as using our money as reserves. Their money is valuable because it's backed up with dollars.”

Bingo, except dollars are not reserves – they are collateral – the asset that backs up a flaky asset.

“Why can't they just keep right on lending for expansion?”

They have to keep on accumulating dollar assets to support letters of credit. NO ONE will accept the word of the Communist Chinese. They have no due process, no law.

“Their money is backed up by the full faith and credit of the chinese government.”

Which is zero, their money is backed up by US dollars – it’s collateralized. This is ultra common in the third world.

“Also, the more factories and patents and raw materials they buy, the more credible the renminbi gets for the reserve currency to replace the dollar....”

Absolutely no amount of economic activity can substitute for due process of law. You either have it or you don’t.

Japan got into deep trouble because she was totally geared as a momentum export machine.

China is in the exact same path and must hit the exact same wall. The only part of her economy that is cranking along is exports. Her ‘banking system’ is even flakier than Japan’s at the top of the bubble. Neither society can handle massive financial failure, resource re-allocation or bankruptcy through orderly court proceedings. Japan finessed her woes by kicking the can around the Kiritzu for ten years. I would expect China to have a major mental malfunction. One can only hope that they are not locked and loaded.

Blert, thank you for responding! I think some of your points are likely to be right, and it's vitally important to find out which ones.

"Beyond that, China’s low labor costs make it already viable to retort coal liquids (1bbl
per ton) while cleaning up their nasty air pollution."

So they're potentially somewhat well-off.

"The world is out of cheap oil, not out of oil. At today’s prices coal, tar sands and ultra heavy Orinoco crude ( double the size of Saudi reserves ) are all economically viable sources of oil."

Sure, we have more $80/barrel oil than we want. Demand falls to meet supply. But for ordinary americans this translates to being out of oil.

""The renminbi is a very sound currency.”"

"It is a coupon currency in the manner of all Communist ‘monies’."

And now ours is joining that crowd. The value of a dollar is what people will sell for it. At the moment the value of the renminbi and the dollar are closely linked -- the chinese government will convert one to the other at a fixed price.

"Absolutely no one wants the Renminbi"

At the moment they're equivalent to dollars. If they break that link, which currency would go down? Lots of people want to buy cheap from china. Lots of people want to sell to the USA, which is a reliable market provided somebody supports the dollar. We don't have any verification yet about which they'd want because the two are linked, and the renminbi is propping up the dollar (I think). We can't really tell which they want, because the experiment hasn't been done. So you might be right.

"“The US dollar is not a sound currency.”"

"The US dollar is international money and is the benchmark for essentially all international trade and most internal trade within non-market economies."

That's true, and that's becoming a significant problem for the rest of the world. They're basing essentially all international trade on an unsound currency, and they have arranged no adequate substitute. It doesn't seem reasonable that they'd keep delaying in solving that problem.

"“It doesn't depreciate all that much because the chinese are pegging it, they keep the dollar high and it costs them to do so.”"

"So the whole relative value is fake and prone to snap collapse, something ultra common in international finance."

Agreed.

"“Suppose they were to cut the dollar loose, and only sell us enough to balance what they buy from us.”"

"Their economic growth would immediately choke down to zero: imports would be throttled. No net increase in letters of credit could be attained. They might as well as put a gun to their head."

Is that true? I can imagine it might be. Why would their imports be throttled? Let's see. They import more from the rest of the world than they export to the rest of the world. Unless they could increase their exports, they'd be running up debts that they couldn't expect to pay with their stocks of depreciated dollars. So unless they could increase their exports to the rest of the world, they'd be in trouble. Yes. They'd have to cut back on imports, unless they could find somebody else to sell to. And would the EU let them do to the EU what they're doing to us? Not likely. OK, you have a good point there. If you're right the chinese should be very careful not to trigger our own meltdown until they have an alternative in place.

"“The dollar would depreciate.”"

"Their exports would rise in cost much to the delight of all other manufacturers. India and Mexico would give them a hat tip."

Yes. Except -- they could cut prices. Maybe they could find some other way to depreciate their currency. Like, oh I dunno, import more from the rest of the world than they export? I think your claim here contradicts some of your other claims. But that doesn't say which of them is right. And economics can be strange, maybe somehow they'd all come out right.

So anyway, if the dollar collapses, why couldn't they peg the renminbi to the euro? I'm not saying they can, I'm wondering. It's hard to predict what would happen in detail in a situation so very different from that today, before the collapse.

"‘We're in a precarious state. We produce something like 40% of the oil we use.”"

"All of our significant rivals produce even lower levels of oil"

That's true. But we're the one with the ballooning debts. If somebody were to lose their credit rating, which would it be? We're buying oil on credit, and if the time comes we can't pay the tab we might wind up exporting some of our 40% rather than importing 60%.

"Of course, Canadian, Mexican, Venezuelan crudes are a strategic lock for us."

If you're saying that our military can keep them from selling to the highest bidder for real money, then you might be right. That's another of those "snap collapse" things, though.

"“We think of the chinese banks as using our money as reserves. Their money is valuable because it's backed up with dollars.”"

"Bingo, except dollars are not reserves – they are collateral – the asset that backs up a flaky asset."

Yes, and bank reserves are sort of collateral, we're in no disagreement here. Except, this is the way we think of it. It might not match the reality. If our dollars are flaky too.... which is more important? Pieces of virtual paper or the ability to pay off in real products? I know the paper could get badly devalued. But on the other hand, the real products aren't worth anything unless somebody wants them. If we are china's only market then they're screwed.

"“Why can't they just keep right on lending for expansion?”"

"They have to keep on accumulating dollar assets to support letters of credit. NO ONE will accept the word of the Communist Chinese. They have no due process, no law."

That's an important point. Maybe no one will give them credit. On the other hand, when no one wants to give us credit, what good are the dollars to them? Will they get credit after all apart from dollars, or will they suffer with us? I think there's a contradiction between saying that if they stop pegging the dollar the renminbi will rise, versus saying it loses value. Still, one or the other is quite likely. ;)

"“Also, the more factories and patents and raw materials they buy, the more credible the renminbi gets for the reserve currency to replace the dollar....”"

"Absolutely no amount of economic activity can substitute for due process of law. You either have it or you don’t."

Good point. On the other hand, american business law is often useless to the point that companies typically write off losses rather than sue. Lawsuits are a form of warfare, you accept your legal lsoses hoping it will cost the other guy more. Business runs on custom -- you don't bomb the other guy's factories or burn down his house, you do hire his top employees out from under him, steal his trade secrets, and steal his patents if you can get away with it. Will world businessmen try to do business with china without dollars? I think so. Will they bet the farm the chinese don't cheat them? Not if they can help it. So it makes sense the renminbi won't be a credible world currency to replace the dollar. But what will? Some replacement is necessary.

"Japan got into deep trouble because she was totally geared as a momentum export machine."

"China is in the exact same path and must hit the exact same wall. The only part of her economy that is cranking along is exports."

I'll expand on that. Japan had a whole lot of people who wanted to work hard and save a lot. But to keep the economy going, what somebody saves somebody else must spend. The japanese banking system had to lend an ungodly amount of money, and they made worse and worse choices. Eventually there was a collapse and people saw that their hard work hadn't gotten them much. The next generation of necessity relaxed -- even if you could get a job that let you work very hard and save a lot of money, why bother? So japan wound up with far less money to invest, and they couldn't dig their way out of their hole as fast as they could have if the spider was ready to get washed down the rainspout once again.

China also has a lot of people who hope to work hard and save a lot of money. But they have a whole lot of peasants who haven't had their chance to try at it yet. If one batch gets discouraged, will the next batch be discouraged too? Also, to the extent that people can be induced to save in banks etc (as opposed to buy gold and bury it in the back yard) china can do a lot of their own financing, as japan did.

I can't speak to the chinese banking system, I don't know enough about it. But they aren't bound by rules the way our system officially is. The japanese got stuck and couldn't do anything about it. If the chinese banking system gets stuck can they just change the rules?

At any rate, you do have some good points. Maybe china isn't doing all this as a weapon against the USA. Maybe they're stuck too, and they'll go down with us. I find that a comforting possibility.

Chester:

"As to your second point, I am not a bond trader, but it strikes me that people will buy anything if it is priced cheaply enough."

In bonds, lower price=higher rate. The greatest danger is that any currency is only as valuable as the market thinks it is. We aren't on the Gold Standard any more, so the worth of the Dollar is only what people believe it to be as a unit of trade value.

If the Chinese dump our bonds, it could cause a "crisis of confidence" in the dollar that would devastate the markets. A "run on the bank", if you will, but of global proportions as traders everywhere try to get out while the gettin's good.

Right now, the equilibrium is there because both sides have avested interest in the staus quo. A finacial "MAD" theory. But if the Chinese ever decide that they want to pull the trigger, we can't stop them. Sure, it would likely decimate their economy, but they have far less to lose than we do. Thier economic prosperity is superficial at this point. The vast majority of their citizens still live in a subsistence economy. The few rich folks could easily be dealt with in the time-honored Chinese traditions, i.e, shot like dogs.

J Thomas:

Yes, the Chinese could simply change the rules. That's the risk for investors in China. They have no tradition of financial transparency nor of the rule of law. If tomorrow the WSJ headlines said: "Chinese nationalize all foreign investments", what could anyone do about it? Call the UN? Sue them?

Always remember that the Chinese Communists will do WHATEVER is necessary to stay in power. They wouldn't give second's thought to what the world capital markets would say. They could hunker down and wait us out. They have lots of peasents and lots of rice. A few million starve? Hey we got BILLIONS of people. We've all forgotten Tienanmin Square already...

Zarba, I'd like to explore the question of chinese dumping our bonds. I can't expect to get things right in detail, in this sort of thing there are always important things we fail to anticipate. But it's worth some thought.

It isn't just the chinese who can pull the plug. There are probably 5 countries who hold enough of our paper to start a run, assuming one or more of the others followed them. The chinese have to be ready to try to get out quick not just when they want to, but when somebody else starts it. But if somebody else starts it, the chinese might be able to bail us out. They'd have to keep buying our worthless securities as fast as everybody else sells them, and then maybe the panic subsides. It would cost them a lot but maybe they could do it. Nobody else could.

OK, so the dollar crashes, and every currency still linked to the dollar crashes with it. But those linked currencies would help support the dollar during the crash. Thailand's baht is pegged to the dollar. Likewise the Ecuador peso. Even during the crash they would help support the dollar.

Presumably no country's currency would stay pegged to the dollar. After the "crisis of confidence", the US dollar would no longer be an acceptable international currency. Over a period of weeks and months the various currencies would adjust, and with no single currency to peg to each currency would float for awhile. Probably a basket of sound currencies would provide some sort of new standard.

The value of the dollar would be determined by our exports, and our imports, and our debts etc. We would not come off particularly well. Likewise the value of the renminbi would depend on their exports and imports and debts etc. I have the idea they wouldn't do so badly, but I don't know.

Now, we want to think they wouldn't start this, because it would hurt them. They would convert many billions of dollars they owned into wastepaper, which would be a loss to them. However, what they're already doing is selling to us particularly cheap -- they're basicly subsidising their exports to us, and using that to shut down american industries. How much would it cost them to bomb those industries, in a shooting war? They're getting that result cheap, considering. And if they were to damage our currency, figuring it would hurt us considerably more than it hurts them -- well, that's war.

The USA may be literally something of a paper tiger now. When the USSR collapsed we didn't beat their army, we judo-tossed their economy until they couldn't pay their army. Could that happen to us? If we annoy the chinese too much, why wouldn't they try it out and see what happens?