Countries Bail Out Banks But Who Bails Out Countries?
As a result of the financial crises of 1998 and 2008,
we’re accustomed to watching countries bail-out banks,
hedge funds, money markets, insurance companies, and
any other too-big-to-fail institutions of the crony
power elite. But, what happens when a country itself
is so indebted that the whole country needs a bail-out?
That’s the situation China finds itself in today. Debt
may have been incurred separately by banks, provinces,
and state-owned-enterprises, but in China it’s all one,
big, happy family. Chinese banks are instruments of the
state. Provincial debt is de facto guaranteed by Beijing.
The state-owned-enterprises are run by loyal Communist
Party members and are also relying on Beijing to ride to
the rescue. When all of the debt is added up it comes to
a whopping $20 trillion, an amount six times larger than
China’s hard currency reserves, and over 200% of GDP.
China will need a combination of inflation, restructuring,
defaults, and IMF assistance to get out of this mess.
When China crashes, they will take much of the world
with them. It will be like a replay of Japan in 1990.
For over thirty years, the U.S. Treasury has misled the
American people about the amount of U.S. Treasury debt
held by the Kingdom of Saudi Arabia. Since 1974, the
Treasury has reported the amount of U.S. debt owned
by various individual countries, but they have always
lumped Saudi Arabia in with other OPEC nations making
it impossible to see the Saudi number on a standalone
basis. Suddenly Treasury decided to report a separate
number for Saudi Arabia. The reported amount is $117
billion. Yet, this number is still a sham. The change
of policy by the Treasury was in response to a Saudi
threat to dump $750 billion of Treasuries on the market,
which would send interest rates sky-high, sink stock
markets, crush property markets, and blow a hole in
the U.S. deficit. The threat came in retaliation for
efforts by the Congress to disclose a classified 28-
page section of the 9/11 Commission report that
discusses Saudi complicity in the 9/11 attacks.
The Treasury disclosure was a belated effort to
calm market fears by showing the Saudis only owned
about 15% of the amount claimed. But countries often
hold U.S. debt through accounts in other countries
such as Belgium and the Cayman Islands. The real total
is probably closer to the $750 billion claimed by the
Saudis. The threat of retaliation is real despite the
Treasury’s efforts at damage control. Click here to
see why you should get ready for volatile and disorderly
markets if the 9/11 legislation is passed.
Interest rate decisions are made by the Federal Open
Market Committee (FOMC) of the U.S. Federal Reserve
System. The FOMC has twelve members consisting of
seven governors based in Washington and five regional
reserve bank presidents from around the country. One
of the regional reserve bank presidents (from New York)
has a permanent seat, and the other four (from the
eleven regions other than New York) serve on a rotating
basis. In truth, the rotating regional reserve bank
presidents don’t have much of a voice. Also, there
are two vacancies among the governors today. One of
the governors, Dan Tarullo, is a regulatory expert
and another, Jay Powell, is a Republican outsider
on a board dominated by Democrats. This means that
the rate decision comes down to a small “gang of four”
consisting of Janet Yellen, Stan Fischer, William Dudley,
and Lael Brainard. Yellen is an academic. Dudley is the
voice of Wall Street. Only Fisher and Brainard have
deep international experience. Right now, Brainard
has Yellen’s ear. She is warning about “spillover”
effects in China and other emerging markets if the
Fed raises interest rates. Brainard is urging caution
in raising rates prematurely, which could cause a global
market meltdown, and sink the U.S. economy. Fischer is
more eager to “normalize” rates. We’ll see whose voice
has more sway over Yellen and Dudley when the FOMC
meets in mid-June.
This may be the shortest story we’ve ever posted with
our news links, but it makes an important point. We
have made the claim that the voices of regional Fed
reserve bank presidents do not carry much weight with
the Fed governors when it comes to rate decisions by
the FOMC. (See the story above for more on this).
James Bullard is President of the Federal Reserve
Bank of St. Louis and is currently a voting member
of the FOMC. That’s an important seat. But, his
public statements about the likelihood of a Fed
rate hike in June have been all over the lot. Now
he says that the so-called “divergence trade” (where
the Fed tightens while the ECB and Bank of Japan ease)
has been “priced in” by the markets. The implication
of this is that the Fed can raise rates in June without
a market disruption since markets already expect a rate
hike and have moved accordingly. But that’s flat-out
wrong. Markets have increased the probability of a rate
hike this year (as measured by Fed funds futures and
surveys), but the expectation is still below 50%. If
the Fed hikes rates in June, markets will react sharply
to adjust expectations from 50% to 100% and more because
expectations of future rate hikes will increase also.
If last December’s “liftoff” is any guide, the Dow
Jones Industrial Average could crash 2,000 points by
the end of July. The Fed may or may not raise rates.
But, Bullard is simply incorrect if he thinks a rate
hike is priced in.
Market analysts, including your editor, spend enormous
amounts of time and effort trying to pick up clues
about the future path of Fed interest rate policy.
The amount of information needed to do the analysis
is huge. It includes speeches, press conferences,
minutes, statements, interviews and third-party
sources such as former Fed officials and plugged-in
insiders. Now the Chinese have an easier way to figure
things out. Just ask! Every year, the U.S. and China
hold a Strategic & Economic Dialogue involving scores
of high-ranking financial and diplomatic officials
from each country. This year the SE&D takes place
in Beijing on June 6-7. The Chinese are deeply
concerned about Fed rate hikes. Any rate hike
makes the dollar stronger in foreign exchange
markets. This causes capital outflows from China
because investors there pull money out of China
and move it to the U.S. in search of higher yields.
This capital outflow causes Chinese markets to crash
as investors sell local stocks and real estate, convert
the yuan to dollars, and move the dollars offshore.
When Chinese markets crash, U.S. markets are not far
behind as we saw last August, and again last January.
China’s message to the U.S. is to go slow and don’t
rock the boat with rate hikes right now. So, what’s
China’s secret plan to find out the Fed’s intentions?
They plan just to ask their U.S. counterparts when
they’re all together in Beijing! We’ll see if the
U.S. gives them a straight answer and if the Chinese
drop any clues afterward.
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