Barack and Beijing

There’s an adage that if you owe a bank a little money and can’t pay it, you’re in trouble. If you owe a bank a lot of money and can’t pay it, the bank is in trouble. But what happens if you owe the bank a lot of money and can’t pay it, but still need to borrow more?

That’s the basic dynamic, I think, in our relationship with China. So far, China has been willing to lend us money to finance our debt–around a trillion dollars to date–and the Obama administration is counting on China to lend much more. This has been going on for a while, but for the first time, the Chinese are worried:

Chinese Premier Wen Jiabao had said Friday he was concerned about the safety of the estimated $1 trillion his country has invested in U.S. government debt. China is Washington’s biggest foreign creditor, and Obama’s administration is counting on the Chinese to help pay for the $787 billion economic stimulus package by buying U.S. bonds.

“Of course we are concerned about the safety of our assets. To be honest, I’m a little bit worried,” Wen said. “I would like to call on the United States to honor its words, stay a credible nation and ensure the safety of Chinese assets.”

President Obama immediately rushed to assure the Chinese that their investment in America is safe:

“There’s a reason why even in the midst of this economic crisis you’ve seen actual increases in investment flows here into the United States,” Obama said. “I think it’s a recognition that the stability not only of our economic system, but also our political system, is extraordinary.

“I think that not just the Chinese government, but every investor, can have absolute confidence in the soundness of investments in the United States,” he added.

Of course, what the Chinese are worried about is not that the United States government will default on its bonds. That obviously won’t happen. The Chinese concern, now being expressed openly for the first time, is that the U.S. will adopt the standard debtor’s remedy of inflating its currency and paying back its debts in shrunken dollars. Why are the Chinese worried about this? Because Barack Obama’s budget proposes to borrow trillions of dollars, injecting them into the U.S. economy without any offsetting wealth being created. The inevitable result, as any economist not in the pay of the Obama administration or the Democratic Party will tell you, is inflation.

Some experts say that the Chinese are stuck, like the bank to whom you owe a lot of money you can’t pay. Therefore, they shouldn’t talk down the dollar lest they further devalue the trillion dollars’ worth they already own:

“I think they’re clearly sending a signal to the U.S. that they’re very concerned with how we’re managing the (economic) crisis,” said Steven Schrage, the director of the international business program at the Center for Strategic and International Studies. “I think they’re also very concerned that this could lead to the helicopter jump of money generation, more cash and inflation. As a way out of the huge fiscal problems that we’re going to be spending huge amounts … which could weaken the value of the U.S. Treasuries they own.”

Schrage was referring to infamous comments made by Ben Bernanke, before he became chairman of the Federal Reserve, that in the event of a deep crisis the Fed could always shower money on the nation from helicopters.

Still, Wen’s criticism reflects a misunderstanding of China’s own risks. In questioning the U.S. ability to make good on its debts, China threatens to undermine the value of the very assets it’s holding.

That confidence may be misplaced, however. Barack Obama’s budget contemplates that over the next five years, the federal government will borrow more money–run up more debt–than has been incurred during the entire history of the Republic, from George Washington to George Bush. It’s easy to draw up a budget that contemplates debt if you’re confident that someone is willing to lend you the money. In reality, though, the only plausible creditor is the Chinese.

With their shot over the bow, I think the Chinese are telling Obama that they don’t like his budget. It is obvious to them that it will cause inflation, even if Obama himself doesn’t understand the problem. Thus, I think they are telling Obama that they are willing to lend our government more money only if 1) the Obama administration follows a more responsible fiscal policy, and 2) in any event, they will insist on higher interest rates in the future to compensate themselves for the risk of inflation. I assume Obama will have to go along, since there seems no prospect of a Plan B.

How ironic: we American conservatives may well be in the position of hoping the “Communist” Chinese can impose fiscal discipline on our shamefully incompetent government.

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