Friday, December 7, 2012

Do We Borrow Money From China? (asked for the umpteenth time)

commentary by Roger Erickson

On the surface, this unfortunately common question is so illogical that it immediately supplies it's own - negative - answer, yet it remains a disturbingly frequent assumption - not even questioned - precisely because so many people question so few of the everyday assumptions they are conditioned to utilize.

Why is the assumption illogical from the outset?

1) Nearly every one of the ~196 countries in the world uses it's own, fiat currency; fiat meaning created "at will."

2) Given that we can create as much fiat currency as we want, to satisfy the liquidity needs of all people wishing to denominate real transactions using $US, why would we ever need to borrow OUR fiat currency from someone else?

3) Since we grant the US Treasury the monopoly right to issue $US, how, operationally, could China lend us our own $US anyway?

4) Given that China issues only it's own fiat currency, Yuan (also called renmimbi), what good would it do even if they did try to lend ours, theirs or anyone else's fiat currency to us?

5) Even if China could and did want to lend us fiat currency, what is it that would they lend to us? THEIR fiat currency?

Case closed. Yet if this expose alone is not sufficient, please try the following historical treatises, in the following order.

fiat currency in ancient Greece (nomisma) and China (Jiaozi)

Colonial fiat currencies preceding the formation of America

Farley Grubb - Public Purpose lecture

Benjamin Franklin and the Birth of a Paper Money Economy

1716 - national fiat currency formally re-invented - John Law

Government Equity and Money: John Law’s System
"The problem is [that] those who studied and reported on John Law didn't understand how a currency actually works, and reported accordingly." Warren Mosler

A Modest Enquiry into the Nature and Necessity of a Paper-Currency - Ben Franklin (1729)

Bishop George Berkeley's 1735 QUERIST

"A prince, who should enact that a certain proportion of his taxes should be paid in a paper money of a certain kind, might thereby give a certain value to this paper money." (Smith, 1776, p. 312)

Abe Lincoln's Greenback Dollar

Marriner Eccle's 1933 Testimony to the US Senate

1946 - Taxes for Revenue Are Obsolete
By Beardsley Ruml, Chairman of the Federal Reserve Bank of New p.35
also see

We Need a Bigger Budget "Deficit" by Nobel Laureate William Vickrey, 1993

7 Deadly Innocent Frauds of Economic Policy - Warren Mosler

Soft Currency Economics - Warren Mosler
see also

Operational details of Reserve Accounting. Do taxes and bonds really finance public spending? Of course not! What does a national “budget deficit” mean, and what are the operating consequences? Math proof:

Fiat Currency Issuer "deficits" = Fiat Currency User "savings"
[to the penny]
"The laws of double-entry bookkeeping dictate that the public sector’s deficit is always and everywhere equal to the private sector’s surplus. Thus, policies that aim to cut the RED INK in the public sector’s position are no different from policies that aim to cut BLACK INK from the private sector."
Robert Eisner's Common Sense Commitment to Full Employment and Activist Fiscal Policy

PBS Frontline video “The Warning”:


Daniel Jones said...

so youre attempting to tell us that china does not really hold roughly 900billion in US debt, or perhaps that the UK does not hold roughly 500billion in US debt, etc etc, simply because those countries have their own fiat currencies? if thats really what you are suggesting here, you are dead wrong and made a fool of yourself. congratulations

Roger Erickson said...

You're conflating sale of US Treasury Bonds and tangible debts of the USA that "limit our ability to express public initiative".

Read the references.

Treasury Bonds are simply a way to drain "banking reserves" from Fed accounts of licensed banks. Why do we do that? Just a relic habit, left over from the gold std days. It's just one - rather convoluted - way of pretending to maintain double-entry accounting even a growing country must generate NEW currency.

Barring any other way of letting "Public Initiative" be a credit to private "currency-user" accounts and a debit to a "currency-issuer" (aka, Treasury) account, calling it a "deficit/debt" is only a semantic trick.

see these too

"The Treasury tax and loan account system was designed as a mechanism for minimizing the dislocations on bank reserves and the money market arising out of the sizable and irregular transfers between the Government and the public."
Treasury tax and loan accounts and Federal Reserve open market operations
TTL Note Accounts and the Money Supply Process

G. Uribe said...

Roger, wouldn't it be simpler just to inform Dan that the "debt" we "owe" China is not a problem when you have a fiat currency to pay it in. The debt is in dollars, not in Yuan. Mosler explains this very simply in his little booklet.

One of the great troubles of blogs is that they are cluttered with people like Daniel: ignorant and emotional shooters from the hip; mentally bone lazy people who don't read or study and argue from a position of sheer ignorance; and who,in short, contribute nothing but noise. They don't deserve a reply.

paul said...

"The debt is in dollars, not in Yuan."

China already had dollars, they opted to trade them for dollars that pay interest, a very good choice and a good deal for China in my view.

China still has the "use" of it's dollars. if it so wishes It can trade them for dollars, other currencies or it could gasp!, buy some stuff from Americans.

This is unlike the situation whereby I borrow your lawnmower. You no longer have the use of it until I return it (pay it back).

Daniel Jones said...

it is a loan, it is a debt, its not a semantic trick.

china bought bonds from the treasury, thats loaning the US government money, which the government then promises to pay back with interest. theres no other logical way to put it than debt.

Daniel Jones said...

you actually think just printing it and inflating the currency and debt away is a good thing?

Dan Kervick said...

What is the problem with calling it a debt? The bonds are US government obligations. The US government has to make the coupon payments, redeem them at maturity.

netbacker said...

Daniel said "it is a loan, it is a debt, its not a semantic trick."

No it is not. Here's why:

When China supplies goods to Walmart, for example, it agrees to receive payments in US dollars. On receiving the goods, Walmart instructs its bank, say BofA, to make payments to the Chinese company. But the Chinese Co doesn't have an account with BofA. So BofA instructs the federal reserve clearing system to credit the Chinese company's account. Again the Chinese company doesn't have an account at the Federal reserve banks. But the Chinese Central bank has an account. So our federal reserve bank credits the Chinese central bank account at the Fed with Walmart's payments. At this stage the payment cycle within the US is completed. Agree?
Now the Chinese company, even though it agreed to receive payment in dollars, actually needs the payment to be in Chinese currency, yuan, so that it can pay its workers and suppliers.
Now what does the Chinese central bank do? It creates Chinese yuan and credits the Chinese company's account. Now the transaction is fully settled, the supplier has received his payment. Agree?

But look what happened in between? The Chinese central bank still has the US dollars credited in their Federal reserve bank account! It hasn't gone anywhere!!
Now the Chinese central bank (CCB for short) has two options, it can either use these dollars to pay for Chinese imports from the US, or say oil from OPEC. But since China run such a huge trade surplus, even after purchasing goods in dollars, it still has a lot of dollars leftover at its account with our Fed. Remember, these are dollars that have already been spent by households and businesses in the US. The account that CCB has with the Fed is similar to our checking account, it pays no interest on the balance that remains in this account. Agree?
Now US offers an option to the Chinese, a favor, not an obligation. It says you can move these dollars from the CCB's checking account to a savings account at the Fed, which will pay them an interest for locking up those dollars for certain periods of time, few months or years. The interest is what the Fed chooses to pay, not what the Chinese wants to lend at. Note the difference. When you walk into a bank to borrow money, it is the lender who fixes the interest rates, not you the borrower. But when China "lends" its unused dollars (that was already spent), it is the Fed that sets this interest rate, not the Chinese banker! So who is borrowing from whom?
If the US chooses, it can stop issuing these bonds tomorrow, after all it is doing a favor to these trading partners and large corporations (and our pension funds,401K,IRA etc) by providing a guaranteed safe investment vehicle that pays interest.
Makes sense?

Tom Hickey said...

netbacker Now what does the Chinese central bank do? It creates Chinese yuan and credits the Chinese company's account. Now the transaction is fully settled, the supplier has received his payment. Agree?

As I understand it, there is a slight twist to this that occurs in China. The PBOC does not credit the entire amount to the supplier in yuan since that would stoke inflation in China. Some of the funds are held back as savings. In effect, the PBOC "borrows" these funds from the firm to sterilize them.

geerussell said...

The PBOC does not credit the entire amount to the supplier in yuan since that would stoke inflation in China. Some of the funds are held back as savings. In effect, the PBOC "borrows" these funds from the firm to sterilize them.


Can you help me wrap my head around that? I don't follow what form the "borrowing" takes in that scheme. Yuan-denominated bonds held by the chinese firm? Some kind of interest-bearing account the firm can access at some point?

Tom Hickey said...

I am unclear on the mechanics inside the PBOC. could be either. The key point is that the PBOC does not allow the yuan don't enter the Chinese economy to increase the circulating medium.

The rules have changed somewhat recently in that Chinese firms are being permitted to hold some USD balances in banks in the US. Previously, they were not permitted to. IIRC, the first round is pretty small balance, with the idea of increasing permitted balances over time as China integrates into the global economy.

Dan Kervick said...

netbacker, I don't understand what that story adds to the bottom line.

Once the US government - whether the Fed or the Treasury - agrees to accept those non-interest bearing dollars held by some Chinese somewhere in exchange for some interest-bearing dollar instrument, the the US government has a debt to those Chinese dollar-swappers, whoever they are. And if fact, not that it matters much, but as I understand it we are mainly talking about treasuries, not interest payments by the Fed.

I think the fact that the debt is not a cause for alarm is getting muddied up with the erroneous claim that it is not even debt at all.

netbacker said...

Dan - All federal debt is just the total of T-security deposits (T-bills, T-notes, T-bonds) in accounts at the Federal Reserve Bank(FRB).

Today, the total federal debt is about 16 trillion dollars. This means the total of deposits in T-security accounts at the Federal Reserve Bank, is about 16 trillion dollars. When you buy a T-bill, you “lend” dollars to the Federal Reserve Bank. You deposit dollars into your T-bill account at the FRB. You are a creditor to the FRB.

Your T-security account at the FRB is essentially identical with your savings account at your local bank. You put dollars in (credit); you take dollars out (debit), and meanwhile you earn a bit of interest.

Whenever you want your dollars back from your “loan,” you merely wire or mail instructions to the FRB to reduce the number in your T-bill savings account, and increase the number in your checking account. The FRB can do this all day long, in any amount. It’s a simple exchange of existing balances.

netbacker said...

Thanks Tom for the clarification on China's PBOC operations.

paul said...

"What is the problem with calling it a debt?"

From my perspective it's a very misleading term. "Debt" is one of the most context-sensitive terms in the language, but it usually gets used in a way that makes it seem "bad".

Usually, when a person holds another persons debt, there is an element of risk. Treasuries are essentially risk-free, at least in comparison to any other store of funds on the planet.

Treasuries are dollars that earn interest, but dollars are debt also. That, in my view would confuse 99.9% of the people.

Traesuries are at the same time "debt" and savings. More confusion.

I suppose it's OK to call something "debt" provided one qualifies the reference.

Arty Produssa said...
This comment has been removed by the author.
Demetri K said...

May I demystify this question for you? We don't borrow dollars from china, we borrow purchasing power to back the dollar. The dollar's value is not determined by the issuer, it is determined by the holder. It's value is driven by people's demand to hold dollars. So China's DEMAND for dollars adds value to the dollar, which is really important when you open your little wallet and go to the store to buy something. Same thing for every other person in the world who demands to hold dollars. You can thank him for your purchasing power, not the "issuer" of the currency. - Demetri

Roger Erickson said...

The currency issuer must then mediate the competition between currency holders, producers and merchants, and manage the currency supply artfully enough to keep the 3 classes cooperating, not competing past surival tolerance limits.

As Warren Mosler says, any financial pressure on the economy can be met with appropriate increase in fiscal spending. Group spending (net currency creation) dilutes the spending power of hoarded liquidity notation (fiat currency) and increases the liquidity of the growing population ... thereby growing the degrees of freedom demanded by an increasingly complex economy.

It's simple, really.

Capability growth demands liquidity growth. Everything else is just the incidental aftermath of added capabilities.