Heroin Trade Inverse

24Mar07

The New Heroin:  Money on the Cheap

History may be repeating itself is a strange way.  A century and a half ago,  the West (mainly Britain) encouraged Opium smoking in the East (mainly China and India) and profited from its trade.  Opium dens devastated China and created widespread addiction in that land. 

 

But recently, China, in serendipitous concert with Japan (which actually makes most of its product for export in China, India, & other low cost countries in the Orient), may have stumbled on a form of revenge on the west by rendering the United States a slave to a new kind of opium:  cheap money & cheap goods.  Here’s how it could be working its effects on us right now.

 

 

Remember that the US Government spends more than it takes in taxes, and that is more true today than at any other time in our history.  Currently it is doing that to support programs like the recent cuts in Estate Taxes and Income Taxes, unfunded Social Security liabilities (which will soon come due as boomers start to retire),  new long term commitments by the current administration for increased Medicare costs (adding subsidies for prescription medicines), ever increasing costs of  the War with Iraq and Afghanistan, increasing costs for Homeland Security & a long list of federally funded social programs.

 

On top of that,  the Federal Government is now borrowing money just to repay the interest on debt that has already been incurred.   Recently, the current administration broke with history and simultaneously cut taxes while increasing expenditures for war and additional entitlements at the same time, something that even Ronal Reagan and George Bush (senior) did not do.   

 

It should be obvious that to obtain the cash needed to pay the bills for its programs, the government must borrow money to make up for what it does not have.  A principal way that it borrows is by selling  “Treasuries” or “T-Bills.”  Note that  Treasuries are really just loan certificates stating that the US Government agrees to pay interest for a set period of time on the principal amount and also agrees to pay back the principal at the end of the term. 

 

These loans go out for various time periods from a few months to many years.  At the end of the term,  Uncle Sam pays back the whole bill, but for the period of the loan, Sam  pays interest to the holder or (“buyer”) of the Treasury Bill. 

 

T-Bills are eventually subject to the law of supply and demand after discounting the short term ups and downs that are not rationally related to economic realities.  Right now,  T Bills pay less interest than comparable Bills sold by Europe so higher interest European Bills should be more attractive than the low interest US T Bill  right?  Well, the attractiveness of a borrower to a lender is about more than just the rate. 

 

 

US T Bills do have one stellar historical advantage over all other forms of national debt instruments in that they have always been considered rock solid. Uncle Sam, has always given the lender his or her money back at the end of the term, and won’t, like some countries like Argentina that offer high interest rates, default on paying you back.  So there is a perceived security benefit that other borrowers, such as the European debt instruments,  or the high interest debt offerings from other countries do not have. 

 

 

On the other hand,  European Bills are not risky by any stretch, so the difference between what a Euro Bill pays in interest and what a T Bill pays in interest should make the Euro much more attractive than it is.  Yet,  T Bills continue to fly off the shelves even as they promise to pay miserably low interest rates to their buyers.  Could it be that somebody has an interest in buying low interest Treasuries that is not based on simple supply and demand.  In other words, might somebody be “lending” us money to keep currency and our credit cheap in the
USA.  Well, combined foreign governments now own 40% of our total debt financed through T-Bills, and their motives for snapping up our debt issues should be cause for debate and possibly some concern.   

 

 

Why, and what would be the motives for foreign creditors to lend money for less than they could earn elsewhere?  Is it just the stability and reliability factor associated with the US Dollar and the high credit rating of the USA. Is it just the fact that they have so many dollars from trade imbalances with us that they need to reinvest in dollar denominated debt? Consider, in the alternative, that the motive might be to control and influence the US consumer’s willingness to spend money to buy goods (which are coming in large part from China and Japan).  After all, a key effect of those miserably low interest rates is that Uncle Sam gets to borrow money on the cheap, and by so doing is able to service its own debt and pay for government programs without, in the short term, raising taxes to pay for them.  Also remember that those cheaply lent dollars ultimately wind up in the hands of the US consumer through private lenders.  Those private lenders, remember,  facilitate US Consumer’s purchases of houses (which, when mortgage rates are low,  appreciate in price since there are so many cheaply lent dollars chasing so few houses for sale) and by secondary lenders who lend homeowners an advance on their house “appreciation” on the bet that the house price will just continue to rise and rise ad infinitum. 

 

 

And ultimately,  what are those consumers doing with their advances on their houses:  they are using the money to buy the massive amounts of cheap consumption goods that they can’t really afford on their static or declining wages.  Their wages are static or in decline because the job they used to have was exported to a country that desperately wants both the job, and even more, the know-how that comes with the job so that they can have it permanently.  To keep us buying their goods during the period that our infrastructure, i.e., our means to produce, are being dismantled and exported to China,  they lend our country money at low interest rates.  We, in turn, use that cheap money to buy their goods all the while transferring our technology infrastructure so that they can make more cheap goods that we can buy with their cheaply lent money.  Some economists think the Chinese and Japanese are stupid for lending us money for such low interest rates.   Really. 

Ok, now its time to fast forward with this scenario of cheap money being supplied by foreign creditors for the purposes of propping up the US consumer and the US government spending long enough facilitate the transfer of this country’s means of production through the transfer of plant and equipment on the misguided premise of US corporations ever cheaper goods are the way of their long term future.

 

 

In a few years China will have all the technical infrastructure (from us) that they need to make anything they want.  We will have transferred it to them via outright shipment of factories, outsourcing, technology sales, or the like.  Right this second, they don’t have all they need,  but at some point in the future, they will cross a threshold, and they will no longer need the technology we are exporting to them or the dollars we exchange for the cheap goods in the first place. 

 

 

At that point, they may decide that they do not need or want to buy T Bills which are not paying much and buy Euros instead.  In March of 2007,  China announced that they would be forming an investment group to manage their foreign currency reserves which total over a Trillion US dollars.  Does anyone doubt that this investment group is going to be focused on getting higher yields than can be had with a US T Bill?  Might the formation of this investment group foreshadow a sea change and an end to cheap foreign loans to support the US consumer?.  

 

In addition, they might “unpeg” their currency from the dollar and let it float to the much higher level it should be (which would make Chinese goods too expensive for us to buy). 

After all,  China could just start making goods for internal consumption.  What would stop them?  Shouldn’t it be a good thing to make most of what you need right in your own country and just import the few things that are made better or less expensively elsewhere, while exporting your superior high value added products (made with the imported infrastructure you managed to wheedle away from unwitting addicts of your cheap money supply?) 

 

 

Ok, now fast forward again to the time that China does not want (or need) to lend us money anymore at low interest rates.  Who is going to buy our T Bills, or put another way,  who is going to lend us money to buy cheap imported goods that we no longer can or know how to make? 

 

 

One source of lenders to make up the foreign exodus from US Treasuries could be a reversion to the US Consumer.  After all, it used to be that Grandma was the biggest purchaser of T Bills (before the foreigners including the Chinese stepped in to buy 40% of our national debt). 

 But now,  remember, the US Consumer will have developed severely limited means of generating income, or savings that might wind up in T Bills,  because he/she has no job or has a lower paying service job (the good jobs having been exported to China  or India so that those countries could make goods cheaply for the US Consumer who bought them using foreign loans).  

 

Further, the US Consumer has failed to save at adequate rates for a long time now, and thus has no cushion of savings to use to buy T Bills.   Without that good paying job (which is now in China or maybe India) the US Consumer will either be unable to buy T Bills, or,  even if he/she has some extra cash,  may be unwilling to buy them because the interest rates Uncle Sam has willing to lend them on was a pittance.

 

So now, Uncle Sam,  being unable to sell his T Bills to compete with other borrowers rates (like the Euro loans or possibly now the China, Japan, or India loans), raises the ante by raising the interest rate he is willing to pay in order to attract more sales of the Bills.  Great,  the few remaining US Consumers with extra cash will snap them up. But, the bad news is that when rates rise,  the cost of money rises along with it,  and low-and-behold,  affordable money for home loans, imported cars, imported toys, or anything else disappears.  And without loans from foreigners, there will now be no money to buy their “cheap” goods. 

 

Beyond that,  the US Government has been servicing its own massive debt by borrowing money to service the debt.  So long as money was cheap,  it could get away with that, but not forever,  Consider the consequences of our huge government debt that has to be serviced using borrowed money whose rates are rising through the roof. It was great while the loan rate was cheap wasn’t it?  Our government’s position is not much different than that of the hapless homeowner who bought an expensive house at the top of the real-estate bubble, and then rashly decided to get the lowest payment possible on that expensive house by taking out a variable interest loan.  When the rate eventually rises, and it will,   the homeowner will be stuck with a higher and higher payment,  just like the
US government will. 

 

It’s at about that time that we will realize that by giving up our means to production (namely our infrastructure for manufacturing and technology), we also give up our means for creating actual (un-borrowed) wealth.  If we continue to give up those means, we as a nation will then be in the unenviable position of owing money for past consumption,  but will be without the infrastructural means of servicing the debt (by producing and selling high quality goods at high prices).  

 

If you think of consumption of cheap goods as analogous to the pleasure induced by Opium you will have entered my den.  For like the opium dealer,  the creator of cheap borrowing wants to make sure that you are hooked.  So,  at first,  the dealer primes your habit cheaply and gradually.  You do not notice, in your opium induced haze, that your house is starting to look messy, and that you are missing work, or that you are borrowing money to buy those Chinese goods, nor that you are starting to sell tools from your garage, and even the technology patents from your employer, to support your habit. 

 

Then,  as you sink deeper and deeper into consumer bliss,  the cost of the consumption drug starts to go up. By then,  you may no longer be working, or, you are working at a low paying third world job.  You are starting to sense that something is wrong, despite your leaders’ encouragement that we are turning the corner or that help is on the way.  But by then,  you are starting to become useless to your money supply dealer. 

And remember, your dealer now has all your tools, not to mention,  all the money you will ever earn.  So, having drained you of all economic usefulness, your lender/dealer walks. 

At that point your may dimly recognize that foreigners, with China in the lead, will then have completed their goal of creating the means to sustain themselves by co-opting the technology and know how that was so willingly and cheaply transferred to them by the USA,  and that they do not need tapped out losers like the American Consumer any longer. 

 

Wal-Mart anyone? 

Rich Brock, Resipsa

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