The Looming Debt and Pension Crisis (part three: China's Latest Threat)

By Kevin Freeman
March 25, 2018Mar 25, 2018

One simple truth of life is that if you spend more than you take in, you have to either cut your spending, increase your income, or borrow some money. That is true for individuals and it is also true for governments.

If you already owe a lot of money, your spending is further crimped by interest and debt payments, meaning you have to earn even more, cut  other (non interest) spending even more, or borrow even more.

This is the unenviable position our nation faces. We now owe more than $21 trillion of Federal Debt. The Congress just passed a $1.3 trillion omnibus spending bill and that will last about six months. Clearly we have not cut spending. In addition, the Federal Reserve is intent on raising interest rates as they did at last week's meeting. With a $21 trillion debt (up $1 trillion in six months), every 1% increase in rates equates to about $210 billion in extra interest expense annually.

In terms of increasing our income, it is true that faster economic growth will help. That was the purpose of the tax cuts, to get faster growth. While somewhat counter-intuitive, lower tax rates can and usually do produce higher tax revenues due to increased growth. And, we have seen a reduction in the regulatory burden, which should further assist growth. Higher interest rates may be somewhat of a drag on the economy but many believe that the impact will be negligible, at least in the early stages. In fact, some believe that normalizing interest rates will help restore confidence. Over the longer term, addressing our nation's huge trade gap and the theft of intellectual property by China will be a positive for economic growth. In the short run, however, it might be negative, especially with fears of a global trade war. When you pull it all together, we may see stronger growth this year but there are multiple cross currents. The bottom line is that we can't count on a sufficient short-term income boost to offset the higher spending, at least not yet.

So, if our Federal income is not rising as fast as our spending, we will have to borrow more. And this is where China is threatening. Last week when we warned the Chinese that we would no longer stand for being at a trade disadvantage and that the days of Intellectual Property theft were ending, they responded with a threat to stop buying our debt.

From Bloomberg:

China Signals It Could Ease Treasury Purchases to Counter Trump

China's ambassador to the U.S. wouldn't rule out the possibility of the Asian nation scaling back purchases of Treasuries in response to tariffs imposed by President Donald Trump.

"We are looking at all options," Ambassador Cui Tiankai told Bloomberg Television, when asked whether China would consider reduced purchases of U.S. Treasuries. "That's why we believe any unilateral and protectionist move would hurt everybody, including the United States itself. It would certainly hurt the daily life of American middle-class people, and the American companies, and the financial markets."

China is America's biggest foreign creditor. It held $1.17 trillion in Treasuries as of January, or about 19 percent of all foreign holdings of U.S. government securities.

The U.S. can ill-afford to see weaker demand for its debt from its major buyers. With budget deficits rising in coming years and tax cuts approved in December expected to hurt revenue, the Treasury has to sell more securities to pay the government's expenses. The Federal Reserve is already scaling back purchases of Treasuries as it gradually reduces its $4.4 trillion balance sheet…. [Read more at Bloomberg…]

This came as a shock to many but is fully in line with previous statements from senior Chinese officials. In fact, we've already seen the Chinese reduce their holdings of our debt over the past six months.

What makes this so significant is that there are only three categories buyers of our national debt: domestic investors, foreign investors, and our Federal Reserve. We already know that the Fed is on a course to reduce its share of our debt. If the Chinese and other foreign sources also stop buying, the burden would fall on domestic parties exclusively. This would likely slow the economy and produce higher interest rates, further exacerbating the economy. That's why the Chinese threat seems so ominous.

Now, it is true that if China dumped our bonds, they would be hurt in the backlash. The value of their debt holdings would fall sharply and their economy would be hurt. But that does not mean they are completely unwilling to take such a risk. In fact, they have been planning for it. Their long-term goal is to supplant our dollar with their yuan. And, they have been collecting allies around the world, most notably Russia.

If the yuan displaced the dollar, our huge debt would prove to be a noose around our economic neck. Unless the rest of the world sees value in our currency, we would be left only with our own buying and the money printing of our government and central bank (aka the Fed). This is essentially the dire situation that Venezuela is facing. Foreigners no longer value the Bolivar and this has created a huge crisis. From The Washington Post:

Venezuela hopes to tackle the world's worst inflation by deleting zeros from its currency

March 23, 2018, CARACAS, Venezuela — Economic pledges may be par for the course in election campaigns, but in hyperinflationary Venezuela, the candidates' dueling promises are going further, with the incumbent vowing to lop a few zeros off the currency, while his main challenger calls for the adoption of the U.S. dollar.

President Nicolás Maduro late Thursday briefly outlined his monetary rescue plan. In a country where a dozen eggs can cost 250,000 bolivars ($5) amid worsening inflation, he would chop three zeros off the currency — arguably bringing the price for those eggs down to 250…. [Read more at The Washington Post…]

At present, we are a long way from Venezuela's collapse. But that fact does not change China's threat or determination to supplant the dollar and place us in a serious position of weakness. Can they do it? That's a fair question but there should be zero doubt about two things. One, we are more vulnerable than we care to admit. Two, the Chinese are planning for that day. This is not the first time we have shared this warning. In fact, we were part of a book a couple of years ago that described in detail the key issues.

One very current signal of Chinese intent is the fact that this coming week, China will offer 24-hour trading of oil contracts in yuan. From the current issue of BARRON'S:

China Seeks Greater Role in Global Oil Trade

Myra P. Saefong March 24, 2018 BARRON'S

…The crude-oil futures will begin changing hands on March 26 on China's Shanghai International Energy Exchange. They will be traded in the Chinese currency, in a market that's ruled by the greenback-denominated West Texas Intermediate, the U.S. benchmark (ticker: CLK8), and Brent crude (LCOK8.UK), its global equivalent. "China is the largest net buyer of oil and [other petroleum] products," says Seymour, and is intent on securing enough energy for its needs.

In 2017, China imported 8.4 million barrels of oil a day, versus 7.9 million for the U.S., according to the Energy Information Administration. China wants its importance as the top importer "reflected in its stature in the world," says Matt Badiali, senior analyst at Banyan Hill. "What better way to do that than to supplant the U.S. dollar with the yuan?" He believes that oil futures traded in China will "become a global benchmark, based on the crude basket that will be offered, and the power of China's economy." They will "directly challenge WTI and Brent." [Read more at BARRON'S…]

If this were the only indication that China wants to dethrone the dollar it would be less significant. But we have so many indications over the past few years that we can no longer afford to keep our head in the sand.

Here are three action steps we should take:

  1. We need to reduce our over-the-top spending. This does not mean that we should slash our military budget (although we definitely need to reduce the waste and bureaucracy there and focus on war-fighting and defense capabilities rather than social engineering). But we must reign in the out-of-control budget process that leads to $1.3 trillion omnibus spending bills.
  2. We must grow our economy faster than we grow our spending. As we have shared, this requires a reduced regulatory burden, free but fair trade with a level playing field, and plugging the holes on Intellectual Property theft.
  3. We must remain prepared to stand up to the Chinese even if it risks short term pain. The further we go down this road, the more disadvantaged we will become so our best time is now.

I would recommend a Breitbart interview with noted China expert Michael Pillsbury. I know Mike and spent some quality time with him and his colleagues when he worked in the Pentagon in the Office of Net Assessment. My mission was to make them aware of the seriousness of the Chinese economic threat. Mike "gets it" as the following excerpts demonstrate:

Michael Pillsbury: Trump Seeks to Thwart China's Hundred-Year Plan for Economic and Military Dominance

by John Hayward 23 March 2018

China expert Michael Pillsbury of the Hudson Institute, author of The Hundred-Year Marathon: China's Secret Strategy to Replace America as the Global Superpower, joined Sirius XM host Rebecca Mansour on Thursday's Breitbart News Tonight to defend President Donald Trump's trade battle with China.

… Pillsbury cautioned that many Americans retain an "out of date" image of China as poor, technologically backwards, and reluctant to provoke economic warfare with wealthier nations while so many of its people struggle with poverty.

"I wrote my book against that idea," he said. "One of President Trump's key advisers, who was obviously present today at the meeting with the president and has gone on television since, is a gentleman – a professor, actually, University of California Irvine in the past – named Peter Navarro. Very courageous fellow, he wrote three books blowing the whistle on Chinese unfair trade practices."

"One of his books is called Crouching Tiger: What China's Militarism Means for the World. What this caused is the opening of a debate among China experts in America: are the Chinese really as friendly and poor? Often people say they will collapse soon. They sort of present a picture of China as about to collapse. While all this debate has been going on, the Chinese have doubled their economy again. They're quite close to passing us. This is really a shock to most people. How can a poor, backward country surpass the size of the American economy? It's just astonishing," he said…

"I happen to think they need us more than we need them," he said. "I don't measure just trade. I measure all the things we've essentially — I hate to use this phrase — given away to China over the last 30 or more years. They still need our investment, our technology, our goodwill, our buying their products, the scientific programs we share with them – there's an extremely long list of the benefits China gets from the United States, counting everything."…

Pillsbury lamented that many people don't appreciate the severity of the challenge to American interests posed by China….

"They want to continue what I described in Hundred-Year Marathon as a kind of stealthy acquisition of the role of the Number One economy in the world. They will blow all that if they follow the kind of rhetoric that the Chinese ambassador in Washington used. He actually did this on Fox News! Fox News called him up, apparently, and he made this comment," he marveled….

"We need to harden our own economy against Chinese theft, Chinese investment," Pillsbury recommended. "Sometimes it can come in a small company. They will buy a technology in a joint venture or through a small company, let's say in Silicon Valley, that no one's ever heard of. Back in the days when robotics and artificial intelligence wasn't a household word, they were acquiring these high technology companies, sometimes very small."

"Frankly that scared friends of mine in the Pentagon, that American military superiority in the world depends largely on technology. Sure, we like to say that we have smarter troops, but technology is a big part of making weapons succeed. If we lose our technological edge, my Pentagon friends told me, we can't get it back," he noted.

"So China will be not only the dominant economy in the world, which they're well on their way to doing, but they'll be the dominant military power in the world. Now, this isn't in the next few months or the next few years, but this is the trend. What President Trump is doing is trying to halt that too with these restrictions on Chinese investment in our high-tech sectors," said Pillsbury.  [These are just excerpts. To read and listen to the full interview, go to Breitbart.]

The Bottom Line is this:  Our ever-increasing national debt makes us vulnerable, not only economically but also as a matter of national security. The massive omnibus spending bill only exacerbated the problem. It is time to WAKE UP and start applying basic wisdom. Our future as a nation depends on it.

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