Fear of China syndrome

I overheard a conversation at a local restaurant on the impact of the US being dependent on China buying US bonds to finance federal debt.  Usullay missing from such conversations is the % of money involved, whether that is a lot, and what effect it has on federal debt and trade (and some kind of political or ‘war’ value?)  Then via Mark Thoma came the Krugman piece on bonds and how the market works in Fear of China syndrome, so thought I would post the Krugman piece and some comment by Mark Sadowski from the post:

Paul Krugman tries, once again, to explain why there’s no reason to fear that “terrible things will happen” if China stops purchasing our government bonds:

Wicksell Goes To China, by Paul Krugman

The idea that we are at the mercy of the Chinese — that terrible things would happen if they stopped buying our bonds — is very influential. Yet it’s just wrong.
Think of it this way: the argument that interest rates would soar if the Chinese bought fewer bonds is the same as the argument that interest rates would soar when the U.S. government sold more bonds — which, as you may recall, was the subject of fierce debate more than three years ago — and you know how that turned out. 

Again, you can think of this in terms Wicksell: we’re in a situation in which the incipient supply of savings — the amount that people would save at full employment — is greater than the incipient demand for investment. And this excess supply of savings leads to a depressed economy. 

What China does by buying bonds is add to the excess savings — which makes our situation worse. (This is just another way of saying that the artificial trade surplus hurts our economy — just another way of stating the same thing). And we want them to do less of it; far from fearing that they will stop, we should welcome the prospect.

Lifted from comments from Economistview:

Mark A. Sadowski said in reply to Matt C…

This is old news. FYI QE2 ended in June of 2011.

On June 30, 2011 the Fed held $1,617 billion worth of Treasuries:
http://www.federalreserve.gov/releases/h41/20110630/

According to the most recent release (August 30) the Fed now holds $1,639 billion worth of Treasuries.
http://ftalphaville.ft.com/blog/2012/08/31/1140881/if-qe3-is-so-close-why-is-the-feds-balance-sheet-shrinking/

According to SIFMA:
http://www.sifma.org/research/statistics.aspx

$1,274 billion in Treasuries were issued between the end of June 2011 and the end of July 2012, meaning the Fed has bought less than 2% of all Treasuries issued in that time.

Moreover, the Fed’s balance sheet has actually been shrinking since December. That’s why there are tons of stories such as this if you bother to do the google:
http://ftalphaville.ft.com/blog/2012/08/31/1140881/if-qe3-is-so-close-why-is-the-feds-balance-sheet-shrinking/
..
Correct current release link:
http://www.federalreserve.gov/releases/h41/Current/

Matt C asked:
Even if QE2 is old news, what is the big change in the financial landscape since 2011?

Was it not bad in 2011 for China to be buying bonds then? If China was depressing the economy by buying bonds then, why wasn’t QE2 doing the same thing?

Mark A. Sadowski answers:
It makes a big difference who’s buying the bonds.

Krugman describes the situation as an excess of savings over desired investment. But another way of looking at it is as an excess demand for money over its supply.

When the Chinese buy US Treasury bonds they increase the demand for US dollars and drive up the dollar’s value (they were of course doing this intentionally to increase their net exports). When the Fed buys bonds they’re adding to the supply of dollars. This of course drives down the value of the dollar.

Increased demand for dollars is depressing. Increased supply of dollars is stimulative.

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