Thursday, September 25, 2008

Mabye the Other Shoe is About to Drop

Yves Smith has me worried that the other shoe is about to drop:
It has been conventional wisdom that China, Japan, and other countries that run trade surpluses with the US, which means they fund our overconsumption by buying assets like US Treauries, would never restrict the flow of credit to us because it would lower their exports and hurt their growth. We've long been leery of the idea that unsustainable trends will have a life eternal, and Brad Setser has a simple reason why this process is self-limiting. Our foreign funding sources aren't just lending us money to buy their goods; they are also providing the funding for interest on the loans extended for past imports. At a certain point, the interest payments become so large relative to the value of the exports that the deal no longer makes sense.

The day of reckoning may be approaching well before Setser's tipping point. And the trigger is much simpler. We look like a lousy risk. The Freddie/Fannie conservatorship, the Lehman bankrutpcy, and the rescue of fallen Asian powerhouse AIG has, not surprisingly, lead to a reassessment of the US's creditworthiness.

Yu Yongding, who has advised China's central bank, urges Japan, China, and Korea to forge an agreement not to dump US bonds. Yu says in no uncertain terms that the Chinese are worried about their US holdings and see a US default as a real possibility.

We've said before that the US is in the same position as Indonesia and Thailand circa 1996, except we have the reserve currency and nukes. The precariousness of our position is now evident to all, save perhaps the average American citizen.

From Bloomberg (hat tip reader a):
Japan, China and other holders of U.S. government debt must quickly reach an agreement to prevent panic sales leading to a global financial collapse, said Yu Yongding....


An agreement is needed so that no nation rushes to sell, ``causing a collapse,'' Yu said. Japan is the biggest owner of U.S. Treasury bills, holding $593 billion, and China is second with $519 billion. Asian countries together hold half of the $2.67 trillion total held by foreign nations....


China's huge holdings of U.S. debt means it must bear a large proportion of the ``burden of sorting things out'' in the U.S., Yu said. China is not in a hurry to dump its U.S. holdings and communication between the two nations every ``couple of days'' is keeping Chinese leaders informed and helping to avoid a potential panic, he added.

``China is very worried about the safety of its assets,'' he said. ``If you want China to keep calm, you must ensure China that its assets are safe.''

Yu said China is helping the U.S. ``in a very big way'' and added that it should get something in return. The U.S. should avoid labeling it an unfair trader and a currency manipulator and not politicize other issues, he said.

So there you have it: not only might the other shoe drop, but just the threat of it happening gives political leverage to the Asian authorities. Of course, we have no one to blame but ourselves.

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