That’s Chinese for Thank You

by Alex Stenback on March 8, 2005

US home buyers have enjoyed persistently low mortgage rates, and might just have the Chinese to thank.

Thankyou_1 Despite the fact that The Federal Reserve has been tightening interest rates, long term rates (mortgage and otherwise) haven’t moved up. None other than Alan Greenspan himself noted this fact as a bit of a "conundrum" recently, when asked why 30 year interest rates have not risen with shorter term rates.

So what gives?  Why have long term rates not moved up, as has been the case with rate hikes by the Federal Reserve over the last half-century?

A recent article at safehaven.com puts forth an interesting (and slightly scary) theory that pegs the blame for this on the Chinese, and their willingness to weather losses in currency (dollars) and US Treasury markets in order to sustain their economic expansion. Should we be worried about this?

Details, pertinent links, Chinese global domination, etc. after the jump. [click below]

Chinese_worker_4According to the article by Michael Alexander, author of Investing in a Secular Bear Market the Chinese have been buying up dollars and US Treasuries in "huge" chunks.  They are doing this not because dollars and US treasuries are a particularly good investment, but because by buying dollars, they are boosting its relative value to their own currency (which keeps Chinese imports ‘cheap’), and in buying US Treasuries, they are enabling the US "borrow-and-spend" boom to continue by keeping borrowing costs low. [photo courtesy of Chris Gregerson, cgstock.com]

Why would they do all of this, even at the prospect of significant losses? It’s all about fueling demand for their goods, and because the Chinese (and other Asian) central banks are willing to risk investment losses in order to achieve the politically valuable: An expanding economy and growing employment.

"Massive imports from Asian economies, particularly China, keeps manufacturing employment growing, providing jobs for unemployed rural workers coming to the cities looking for a better life. In China, these large numbers of unemployed rural workers represent a significant potential for political unrest, which poses a threat to the ruling elite. It is in the interest of the Chinese political elite that employment opportunities expand at the fastest rate possible."

The article takes the position that this is evidence of politics trumping economics (and draws some interesting parallels between today and WWII, when US central banks took similar risks/losses to sustain a war economy.) Though the political implications of the fact that the United States current "borrow and spend" spree may be supported by Chinese market manipulations is cause for concern (a coordinated sell-off chief among them,) we think ultimately, economics will prevail.

Rather than a case of politics ‘trumping’ economics, we see it like this: The Chinese are willing to risk losses in one market (currency and treasuries) for the vastly superior economic (and also political, to the extent that national economies and politics are coupled) benefits of fueling a growing economy – which needs, more than anything else, a market for its goods.  That market happens to be the United States, so it is hard to envision a scenario in which the Chinese would deliberately wipe out its largest customer. 

Of course, history is littered with examples of nations acting against the economic interest of their citizens to achieve a political goal (North Korea, for example,) so anything can happen – but we’ll leave the ‘Red China aiming for global dominance’ [321 energy, via The Big Picture] paranoia to others.

For now, maybe ‘buying Chinese’ will keep those mortgage rates low.

Read More:
Inflation, Monetary Stimulation, and Interest Rates – A Cycle Perspective
[safehaven.com - Michael Alexander]
Greenspan’s Conundrum [Newsweek via MSNBC]

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