Wednesday, August 8, 2007

A Funny Party's Funny Logic on U.S. Bonds

The Chinese Communist Party has just launched an economic campaign against the United States based on some "funny" logic. In particular, the Chinese Communist Party is warning that if the U.S. keeps putting pressure on the Chinese Communist Party to appreciate the Chinese Yuan against the U.S. dollar, it will enact a mass sale-off of U.S. Treasury bonds that it has accumulated due to exchange rate manipulation for many years. What is so funny about this so-called campaign?

According to the Chinese Communist Party's funny logic, a mass sale-off of U.S. bonds will cause a hard time for the U.S. Treasury to sell new bonds and at the same time cause a fast depreciation of the U.S. dollars.

This does not impose a problem to the U.S. economy cause the Federal Reserve has been ready to raise the interest rate due to rising inflation rate in the U.S. When interest rate is raised, the Treasury will be able to sell new bonds without much difficulty.

Moreover, if the Chinese Communist Party sells its U.S. bond holding, then it will first suffer a severe capital loss because of the rise in the U.S. interest rate in recent years. The Chinese Communist Party has started to accumulate U.S. bonds when its interest rate was still around 1.75-2%. The capital loss is enlarged when the U.S. Treasury is forced to raise T-bond rates to sell new bonds after the mass sale-off by the Chinese Communist Party.

Furthermore, the current interest rate in Europe is about 3.5%, whereas that in the U.S. is about 5%. A shift from holding U.S. bonds to holding European bonds means a fall in yield which is certainly not to the interest of China. The sudden large-scale purchase of European bonds also implies a large scale purchase of Euro creating a depreciation of Yuan against Euro. Such a depreciation will obviously not be welcomed by European countries. Given the already-poor trade relation between China and Europe, such a move is doomed to be disastrous to China.

An alternative is that the Chinese Communist Party simply hoards or destroys the Yuan after the sale-off of the U.S. bonds. After so many years of letting the U.S. enjoy cheap products from China, this simply means that the Chinese Communist Party is getting nothing in return. Still another alternative is that it may use the yuans from bond sales to buy back some Chinese bonds from the Chinese people. This will lower the interest rate in China and is certainly against its recent effort to curb inflation. The buying of bonds from the Chinese public will also result in an increase in their stock purchase, making the current stock market bubble even larger.

In any case, the mass sale-off of U.S. bonds will cause an instant appreciation of Yuan. This is exactly what the U.S. government is ask for. The question is whether the Chinese Communist Party can afford to have a 50-200% appreciation of Yuan over-night! Who on earth will buy low-quality Chinese products that are 50%-200% more expensive than those produced in Vietnam? Just the thinking of this will certainly drive away many factories in China instantly. Another question is whether Europe will remain silent when Euro appreciates at an unprecedented rate, despite of its low interest rate. The Chinese Communist Party is simply declaring wars against all advanced nations in the world! Perhaps the Chinese Communist Party is trying to cook up another reason why the U.S. should boycott Beijing Olympics, namely, for trade retaliation which is economic and not political.