The Chinese have raised their interest rates, causing a ripple effect in markets across the globe.
So, what are the ramifications of this move?
First, we note that this is something that the US officials have been pushing for, at least in theory. The political and economic saber rattling in recent weeks has been part of the race to debase, in which the major developed nations have been eager participants. Our leaders seem to have succeeded in persuading the Chinese officials to strengthen their currency.
As the theory goes, this will be good for US exports. With a stronger currency, the Chinese people will be able to afford to buy more of our manufactured goods. This will bolster the American economy in general, and manufacturing jobs in particular. This would all be good theory if we actually made things that the Chinese buy.
But we don’t, so it isn’t.
In practice, this is simply part of the unfolding of some inevitable economic problems. It seems that there are a couple of ways that this could play out. What will certainly happen is that as the Chinese currency rises, Chinese goods will become more expensive. And you may have noticed that a lot of things that you buy are made in China.
In the future you will be paying more for these things. Some might call it price inflation. Some might call it lower living standards. Whatever you call it, the stuff they make will cost you more of your hard earned dollars.
The result of this is that we will buy less stuff from China. This will actually represent an improvement in our balance of trade with China. In other words, if we buy less stuff from them, then the trade deficit will decrease.
But this has further ramifications. As we buy less stuff from China, China accumulates fewer dollars in their foreign currency reserves. They then have fewer dollars with which to buy Treasury bills. As the market for T-bills shrinks, then bond prices fall and rates rise.
Rising rates
There are a lot of reasons that the US Government does not want rising rates. I can think of about 13.6 trillion reasons right off the top of my head. Rising rates means higher borrowing costs for the already massive, exponentially expanding government debt, which will make the already obvious bankrupt nature of government finances even more obvious.
With higher debt costs, our government is faced with essentially two options: Austerity or Inflation. Some austerity would be a great thing. If I were king for a day, austerity it would be, and lots of it. Austerity would involve a reduction in size and expanse of government. People would be laid off, unemployment would go up.
Sure it would be hard for all the government workers who lose their so-called jobs, but these people aren’t, after all, producing anything, and they most certainly are not manufacturing goods to sell to the Chinese. Laying these people off would be painful to them, but it would be a relief to the rest of us who pay their bloated salaries and pensions.
Reducing the bloat in the public sector would be good for the private sector. In fact, it is just what our economy needs. So lets hope for some austerity, and the sooner the better.
But alas, such hope is probably in vain. I was speaking earlier today with Alice, who put it rather succinctly: “Politicians hate austerity.” We can be sure the those in charge inside the beltway, that is, the primary beneficiaries of government bloat, will fight against austerity measures zealously.
Fighting austerity means that they continue to spend. Austerity, after all, is the opposite of spending. They want to continue to hand out government services, for such is their path to power and the manner in which it is maintained. In the current environment, continued spending means continued borrowing, which means that interest rates must remain low.
So, a new buyer must be found for the Treasury notes and bills. And we know who that will be: The Federal Reserve. The Fed will be the new purchaser of government bonds. And just in case anyone thinks that this is too far fetched, let me remind our readers that this is already happening - the Fed is already one of the largest owners of Treasuries on the planet.
The Federal Reserve, then, will be buying more government bonds. Buying them with what, you may ask? The Federal Reserve, of course, has no reserves. They print them as needed. This is called "monetization", although some people prefer to use other terms such as “inflating the money supply” or “counterfeiting” or “stealing”.
We have had episodes of deflation in our nation’s history, but there is little doubt about the long term trend, and it is inflationary. Is there really any doubt that the digital printing presses will soon be kicked up a notch?
The price of gold dipped on the news today. With the Chinese raising their rates, it appears that one of the players in the currency debasement game might be competing with a little less enthusiasm, and the gold price responds by moving inversely to currencies. For the price of gold in US dollars, however, the long term reasons for bullishness on the gold price remain in tact. All 13.6 trillion of them.