China and the U.S. Debt

I’m warming up for a longish Beginners-style article on government debt, which will come out next week or so. In the meantime, the New York Times has an article today about China’s diminishing demand for U.S. dollar-denominated debt. Theoretically this could make it harder for the U.S. to borrow money and thereby push up the interest rates on our debt (now at extremely low levels).

China’s voracious demand for American bonds has helped keep interest rates low for borrowers ranging from the federal government to home buyers. Reduced Chinese enthusiasm for buying American bonds will reduce this dampening effect.

However, the article doesn’t mention one compensating factor. The fall in China’s buildup of its foreign currency reserves is linked to the rise in the U.S. savings rate, which is projected to rise to as much as 6-10% (it was over 10% in the 1980s). Some of that new savings will go to pay down debt, but a lot will go into savings accounts, CDs, money market funds, and mutual funds – which means that depresses interest rates across the board. On the back of the envelope, 6% of personal income is about $600 billion a year in new domestic savings to compensate for reduced overseas investment. Whether this will be enough to compensate entirely I don’t know. But if we were all one global economy in the boom, we’re still one global economy in the bust.

Originally published at the Baseline Scenario and reproduced here with the author’s permission.

2 Responses to "China and the U.S. Debt"

  1. Guest   January 12, 2009 at 7:14 am

    Thank you Mr. Kwak.Personally, think a 6-10% increase in the American savings rate it is extremely hopeful. Here’s why: In contrast to the 1980’s, we now have a generation of Americans who have never set up a routine savings plan. It’s been their habit to over consume by spending every penny they made and every other penny they could borrow. It’s just not in their DNA, so to speak, to save. How much this generation will eat away at this predicted 6-10% I don’t know. Couple this generation with people who will be out of a job and simply won’t be able to save, and then throw in (possibly) a good dose of inflation later in the year, and perhaps rising interest rates ….. a 3-5% increase in savings seems more likely to me.And personally, I believe we have a few more Bernie Madoff’s in our windshield, as well as a large bank or two going under, such as Citi and BofA. How will this spark savings confidence – in banks, not in mattresses? Three more Madoff’s (I predict there will be a scam even larger than Madoff’s by summer) alone could wipe out $150 billion of liquidity. That’s 1/4 of the $600 billion we’d need to replace China.Just food for thought.

  2. George Harter   January 18, 2009 at 7:50 am

    Dear Mr. Kwak,As another has stated, I also believe a reversal in savings rates especially to 6-10% is literally impossible.For the last few years I would say we have lived with a negative savings rate (taking on increasing debt burdens) This has financed our presently outrageous levels of consumption of both goods and services. Now deeply into the start of a rather deep and long Hyper-Recession(read Depression) America’s ability to deal with financial difficulties will lag.Credit Card Debt mounts with extra charges, higher rates. Unemployment expands, hours lost, medical costs rise inexorably at 10+% / year(our estimate is roughly 25% of GDP by 2016) environmental tolls in the once booming sun belt (water???). The boat may be settling at a faster rate than we can manage.Families will be hard pressed to met financial obligations. And though it is easy for the upper class to say “Save Anyhow!” if it becomes a choice between surgery for a daughter and savings, savings loses.America has lost its ability to finance this endless give away to banks. The smart money is not the size of the old Chinese Fed Purchasing. NO, if the Chinese slow down, drop to a 35% rate of Note purchases, America can not make up the difference right now. In three years, maybe.Raises in interest rates paid by the Fed, I believe are inevitable. 5%, 10% who knows. It just adds to the deficit growth which will now compound vigorously, debt service will become a substantial portion of the budget.You know, even paying 10% may be better than what China itself is facing.