How China Ran the Japanese Playbook

Craig Dougherty has been a banker for 20 years, and was the President of the Union Bank Private Capital Group. He was the former CFO of Replay TV (now part of Direct TV), and was co-founder of Content & Company.


The Chinese took a page out the Japanese playbook, and re-invested the FX reserves earned from their burgeoning current account surplus into US Treasuries. This is how they kept the yuan from appreciating, which induced more and more companies to invest in Chinese manufacturing (i.e. low cost labor) – which perpetuated the surplus. Of course, the normal corrective action of an appreciating currency bringing down a surplus never happened, which was the intent of the Chinese!

The Chinese took away Western manufacturing, they got jobs for their peasants, and huge trade surplus … but now own huge amounts of Treasuries as the price.

Going forward, they now dominate manufacturing, so they don’t have to artificially suppress the yuan nearly as much as before. And they are free to invest their hard currency reserves not in UST, but in hard assets/materials/oil, etc. And precious metals.

We got screwed as a nation. The US Chamber of Commerce, wielding extraordinary power on behalf of their constituents (US corporations) … well, they’re happy as big US multinationals just moved manufacturing offshore, to low wage countries. They benefit via lower labor costs.

The US worker got fucked.

The bond market going forward? The Fed has become the default buyer, as the Chinese are buying less. As the Japanese buy less, and other BRIC nations follow the Chinese lead and buy hard assets, there will be less demand for a huge supply of Treasuries. With the Fed ending QEII, $600 billion in demand goes away. They WILL re-invest the interest from the securities on their $3 trillion balance sheet, but you still have a $600 billion buyer leaving the market.

This is why Bill Gross has said adios.

IF our clueless, bought-off politicians did something meaningful on the budget (defense, ag and energy subsidies, Medicare, buying generics, re-importation of drugs from Canada …. I could go on), the equity markets would rally, and the wealth effect Bernanke has created successfully via QE I and II would continue WITHOUT QE III.

If not, I submit higher rates when the national debt rises inexorably will kill us. 25% of revenues for debt service is not far off.

Once you’re national debt starts to creep over 90% of GDP, it’s a slippery slope that’s hard to get off.

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