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Monday, August 13, 2007


they could and should -- but will they?

i mentioned the chinese comments on the dollar last week:

the oft-resorted-to fallback that china would never intentionally depreciate an asset it holds so much of doesn't carry much water with me. i think they'd be more than willing to take a 20-30% haircut for the right policy goals, knowing that the damage in the united states would be massively larger.

brad setser opines further.

The general consensus in the US is that China cannot cut off the US without “shooting itself in the foot."

I disagree. At least in part.

China is already shooting itself in the foot – financially speaking. It loses money every time it buys another dollar bonds. The dollar will depreciate against the RMB some day, leaving China – which finances its purchase of dollars by selling RMB-denominated debt – with large losses.

And, generally speaking, adding to a losing position adds to your ultimate losses.

China would be better off financially if it let the RMB appreciate substantially, stopped financing the US and took large losses now rather than continuing to finance the US, adding to its stock of dollars and adding to the scale of its future losses. A bank that is lending to a failing company reduces its ultimate loss by cutting the company off and taking its lumps now, not by covering ever bigger losses with new loans to avoid “turmoil.” China is in a similar position. The US isn’t a failing company, but China is lending to the US on terms that imply very large financial losses for China.

China’s real problem is that it cannot stop financing the US without shooting its own exporters’ in the foot.

Up until now, China’s exporting interests (perhaps in conjunction with all those who benefit from loose monetary policy) have driven Chinese policy. But the interests of China’s exporters aren’t quite the same as the interests of China writ large.

By the same token, the interest of US firms with operations in China – or US firms that rely on Taiwanese and Hong Kong firms with supply chains that stretch back into China -- aren’t quite the same of the interests of the US as whole. There are parts of the US economy that have benefited from China’s policy of subsidizing US consumption, and US borrowing, but there are also parts that haven’t.

... The possibility that China might cut the US off is remote – barring a confrontation over Taiwan. But it also isn’t totally beyond the realm of possibility that China might someday change a policy that many in China think benefits the US more than it benefits China. That is one reason why the balance of financial terror may not be quite as stable as it now seems. The costs associating with maintaining the status quo – most notably the costs associated with China’s huge dollar position – are growing, not falling.

on balance, it isn't good for them or for us -- the largest thing blockading movement is inertia. how long can that last?

probably quite a while longer, but i just do not and will not know.

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