How will China dump the dollar?

Peter Schiff says in Friday's Market Oracle that although Alan Greenspan thinks the Chinese must continue to hold US bonds since there is no-one else to sell them to...

...the Chinese do not have to sell, they only need to stop buying and let their existing bonds mature. Then the U.S. government, not the Chinese, will be the ones forced to find new buyers for its debt.

Most of the debt that the Chinese own is short-term. Therefore all the Chinese need to do is simply not re-purchase new Treasuries when the U.S. pays them for their existing notes. Perhaps Greenspan should rent a copy of the 1981 Kris Kristofferson movie “Rollover,” where the fear that Arab countries would not rollover maturing treasuries sent gold prices soaring.

Of course, even if the Chinese decide to cash out, they will be repaid in dollars, for which they will actually have to find buyers.

[...] To expect 1.3 billion hard-working, underpaid Chinese to indefinitely subsidize 300 million wealthy, over-consuming Americans is absurd. [...] When the Chinese finally wake up the American dream will disappear.

Finding someone to accept the dollars sounds a bit easier, especially if you are prepared to be a bit generous in the exchange. If you were the Chinese, what would you do?

Following this line of argument, if there is less demand for US Treasuries, their price drops and therefore their yield (the ratio of interest to purchase price) increases, which means higher interest rates. Which will make many debtors very uncomfortable or insolvent, and which will also force consumers to cut back on discretionary spending.

Lower demand means more unemployment, I guess, and a falling dollar means imports will cost more; also, exports will be cheaper to foreigners, who can therefore afford to pay more, so rasing the cost of those items in dollars. So, slumpflation for Americans?

But if countries across the world have been inflating their money supply to keep pace with the USA, maybe they will deflate in concert, too. So, maybe simply a deflationary slump, a worldwide bust?

I look forward to reading some expert who can explain the least painful way out of this. Breaking up factories to reduce oversupply?

No wonder no-one wants to be the first to burst the balloon.

Quick fix or cold turkey?

Alan Greenspan seems to think relaxing rules on immigration will help America. I think this is short-sighted.

If it's about keeping down wage costs, remember that low-paid workers also claim on a range of social benefits, and the people they are undercutting even more so. The last thing a country needs is a hereditary class of long-term unemployed.

If it's about skill shortages, highly-skilled foreign workers are getting harder to find: as emerging economies develop, they want the same people. My brother in America notes that over the years, his university has attracted fewer foreign mathematicians for this reason.

The quick-fix approach is not a lasting solution. Like the UK, America needs to improve education and vocational training. If times get tough and foreign workers go home, the USA's dependence on them could result in economic "cold turkey".

What is Alan Greenspan doing?

Recently, ex-Federal Reserve Chairman Alan Greenspan has been sounding warnings about the US economy and is now aware that his back-seat driver comments may affect the market (see end of this article). It must be irritating for Ben Bernanke to deal with a boat-rocker whom some blame for creating the problems that Ben now faces.

And what is Mr Greenspan now doing? One of his new roles is as an adviser to investment managers PIMCO - see here for their latest US report. The style of the report is an uncomfortable combination of stuffy and jazzy, but the substance is interesting. Here's a few extracted phrases:

Currently there's a "virtuous circle favoring capital at the expense of labor", which only "a global financial bubble popping of sorts, an accelerated decline of U.S. housing in the short run, or a U.S.-led trade policy reversal that could precipitate counter-attacks from Asian exporters" could stop;

there are "inflationary pressures" in the US and an "asset bubble";
if a housing slump hits the American consumer economy, "anti-trade [i.e. protectionist] legislation may or may not become a reality";

"The emphasis on emerging market currencies rather obviously suggests relative weakness of the U.S. dollar. We continue to believe that U.S. growth will descend towards the lower quartile of countries within a broad global composite. Such U.S. growth, despite relatively favorable demographic labor force trends spiked by immigration, will suffer due to reduced U.S. consumption and the need for higher savings. Even in the face of resistance by Chinese authorities vis-à-vis the Yuan and the Japanese via artificially low interest rates, this lower growth speaks to a weaker dollar and lower relative asset price appreciation in comparison to the rest of the world. PIMCO portfolios will therefore likely feature increasing international diversification in foreign currency terms.";

PIMCO thinks that "sustainable global growth with perhaps an early cyclical slowdown appears to be the likeliest outcome. Those who “own” this growth as opposed to those who lend to it will benefit."

Not hard to boil this down. But potentially rewarding for an alert and adventurous investor. And Mr Greenspan the poacher will act as your gamekeeper, if you go with PIMCO.