National Security is Threatened by Economic Security
We are no longer in control of our economic security, China and other countries are.
This is all fine and good. But are we looking in the right places? If the head of Homeland Security were to ask me where this country could really get hurt I would say "in the economy." I would tell them that we have become extremely vulnerable to economic shocks.
Through globalization, dollar hegemony, and central bank intervention, the U.S. has lived beyond its means for some time now and incurred huge external debt. It used to be that 70% or more of this debt (when it was much smaller) was held by U.S. taxpayers. Now over 55% of that debt (not even including agency and corporate debt) is held by foreigners. Most of that debt is held by China and Japan.
This is where the insecurity comes from. If China decided for whatever reason to curb their purchases of that debt, or even worse actually try to sell it in the open market, it could crash the dollar, send U.S. interest rates up precipitously, and throw the free money U.S. economy into a tailspin.
Bulls scoff at this scenario for they say it would mean the destruction of China's economy as well: China owns $800 billion in U.S. public debt and a significant loss in the dollar (their investment) would hurt them just as much. It is irrational to think China would hurt themselves.
Is it? How could China protect its dollar investment as they facilitated a crash in the dollar?
If the dollar lost half its value, the Chinese would lose $400 billion or so in real wealth on the U.S. bonds they own. But if they had bought enough gold prior to selling (before the market became aware of what they were doing), a rise in a certain amount of gold could totally offset their losses in the dollar.
We figured roughly that the Chinese would have to amass 3,900 tons of gold to offset a 50% decline in the dollar. We figured that it is very feasible to amass this amount of gold over a two year period. Hmmmmm....
My point is not that China would do this, it is that it could do it. Do we really trust the Chinese with our economic survival?
This is the mess our politicians and the Fed have gotten us into. We are no longer in control of our economic security, China and other countries are.
This was one of the more interesting lines of questioning by one Senator during Bernanke's economic testimony last week. Of course no one really followed its implications.
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