Posted by Rojas @ 2:14 am on March 25th 2009

Brace for impact

As Obama speaks, the worm turns elsewhere.

My old high school debate opponent Brad Setser interprets newly released January data to mean that other nations are ceasing to buy US treasury notes. Apparently they’re unconvinced that the US government is a particularly good investment at the moment.

If this trend holds, it’s going to mean some very specific and ugly things in terms of US economic policy. Our existing means of financing our public debt is to sell bonds internationally. If we can’t do that, we are left with a choice between 1. selling them domestically, 2. radically reducing public debt, or 3. engaging in de facto debt financing by inflating the currency.

Option one means that government bond sales end up crowding out all kinds of private sector investment that is critical to economic recovery. Option two immediately ends existing government stimulus measures and crib-smothers the broader Obama agenda. Option three very likely ends all future prospect of foreign deficit financing, possibly causes the global abandonment of the dollar as reserve currency (which is A Very Bad Thing), and does all the other delightful things that inflation does.

It is, of course, too early to read the data as definitive or indicative of a broader trend. We’d better hope it isn’t, because if it is, our options are about to become severely constrained, and the discussions currently being had in Washington about how to fix the economy are about to become immaterial.


  1. I don’t think China in particular could be any more clear that they’re dissatisfied with the dollar as reserve currency and are actively shopping around for other options.

    China’s central bank on Monday proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund.

    In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.

    Analysts said the proposal was an indication of Beijing’s fears that actions being taken to save the domestic US economy would have a negative impact on China.

    “This is a clear sign that China, as the largest holder of US dollar financial assets, is concerned about the potential inflationary risk of the US Federal Reserve printing money,” said Qu Hongbin, chief China economist for HSBC.

    Although Mr Zhou did not mention the US dollar, the essay gave a pointed critique of the current dollar-dominated monetary system.

    “The outbreak of the [current] crisis and its spillover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system,” Mr Zhou wrote.

    Russia is making similar noises.

    Be awhile yet before any of that ever comes to fruition. My own sense is that this is just the first in what will probably be a half a dozen or so tipping points. But if there were a consumer confidence index for the dollar, it would be spiking downward right about now.

    Be a long while yet before that happens

    Comment by Brad — 3/25/2009 @ 10:30 am

  2. The reserve currency thing is particularly apocalyptic (and rather less likely than some of the other outcomess), but it’s not our only reason for concern.

    In particular, one shouldn’t conflate it with the other problems that arise from a lack of overseas deficit financing. The non-inflationary consequences of that situation could be pretty immediate, and if the existing trends hold up, the triggering mechanism has been underway since earlier this year.

    It’s the crowd-out that concerns me most, I think. Obama has been particularly insistent that he regards his entire policy agenda as critical to the nation’s economic future, not just the stimulus portions. The problem is that if that agenda is generated by domestic bond sales, there simply won’t be enough investment money available to generate growth in other sectors. This is the perfect recipe for turning a recession into a depression.

    Comment by Rojas — 3/25/2009 @ 12:43 pm

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