Page 1 of 2 China in Treasuries cul-de-sac
By Henry CK Liu
Many have suggested China is not compelled to buy United States Treasuries with
its trade surplus dollars. They point out that China does so voluntarily
because US sovereign debt is the safest instrument as a storer of value. This
is now obviously no longer true. So why does China continue to buy US sovereign
debt? The answer is China has no other options but to be a creditor to the US,
due to the US-China trade imbalance. The following explains why.
A debt is not an independent thing. It is a designation of financial
relationship between parties. For a debt to exist between parties, one party,
or parties, must be the debtor, or debtors, and a
counterparty or counterparties must be the creditor, or creditors. A debt
cannot exist without a counterbalancing credit position.
Credit drives the economy, not debt. Debt is the mirror reflection of credit.
Even the most accurate mirror does violence to the symmetry of its reflection.
Why does a mirror turn an image right to left and not upside down as the lens
of a camera does? The scientific answer is that a mirror image transforms front
to back rather than left to right as commonly assumed. Yet we often accept this
aberrant mirror distortion as uncolored truth, and we unthinkingly consider the
distorted reflection in the mirror as a perfect representation.
In the language of finance economics, credit and debt are opposites but not
identical. In fact, credit and debt operate in reverse relations. Credit
requires a positive net worth and debt does not. One can have good credit and
no debt. High debt lowers credit rating. When one understands credit, one
understands the main force behind the modern finance economy, which is driven
by credit and stalled by debt. Behaviorally, debt distorts marginal utility
calculations and rearranges disposable income. Debt turns corporate shares into
Giffen goods, demand for which increases when their prices go up, and creates
what former Federal Reserve Board chairman Alan Greenspan calls "irrational
exuberance", the economic man gone mad.
Monetary economists view government-issued money as a sovereign debt instrument
with zero maturity, historically derived from the bill of exchange in free
banking. This view is valid only for specie money, which is a debt certificate
that can claim on demand a prescribed amount of gold or other specie of
intrinsic value. But fiat money issued by a sovereign government is not a
sovereign debt but a sovereign credit instrument.
Sovereign government bonds are sovereign debt while local government bonds are
agency debt but not sovereign debt, because local governments, while they
possess limited power to tax, cannot print money, which is the exclusive
authority of the Federal government or a central government. When money buys
bonds, the transaction represents sovereign credit canceling public or
corporate debt. This relationship is rather straightforward but is of
Money issued by government fiat is now exclusive legal tender in all modern
national economies. The State Theory of Money (Chartalism) holds that the
general acceptance of government-issued fiat currency rests fundamentally on
government's authority to tax. Government's willingness to accept the fiat
currency it issues for payment of taxes gives such issuance currency within a
national economy. That currency is sovereign credit for tax liabilities, which
are dischargeable by credit instruments issued by government in the form of
When issuing fiat money, the government owes no one anything except to make
good a promise to accept its money for tax payment. A central banking regime
operates on the notion of government-issued fiat money as sovereign credit. A
central bank operates essentially as a lender of last resort to a nation's
banking system, drawing on sovereign credit. A lender's position is a creditor
Thomas Jefferson famously prophesied: "If the American people allow the banks
to control the issuance of their currency, first by inflation, and then by
deflation, the banks and corporations that will grow up around them will
deprive people of all property until their children will wake up homeless on
the continent their fathers occupied ... The issuing power of money should be
taken from the banks and restored to Congress and the people to whom it
belongs." This warning applies to all other peoples in the world as well.
Government levies taxes not to finance its operations, but to give value to its
fiat money as sovereign credit instruments. If it chooses to, government can
finance its operation entirely through user fees, as some fiscal conservatives
suggest. A government does not need to be indebted to the public. It creates a
government debt component to provide a benchmark interest rate to anchor the
private debt market, not because it needs money. Technically, a sovereign
government need never borrow. It can issue tax credit in the form of fiat money
to meet all its liabilities. And only a sovereign government can issue fiat
money as sovereign credit.
If fiat money is not sovereign debt, then the entire conceptual structure of
finance capitalism is subject to reordering, just as physics was subject to
reordering when man's worldview changed with the realization that the earth is
not stationary nor is it the center of the universe. The need for capital
formation to finance socially useful development will be exposed as a cruel
hoax, as sovereign credit can finance all socially useful development without
problem. Private savings are not necessary to finance public socio-economic
development, since private savings are not required for the supply of sovereign
credit. Thus the relationship between the national private savings rate and
public finance is at best indirect.
Sovereign credit can finance an economy in which unemployment is unknown, with
wages constantly rising to provide consumer buying power to prevent production
overcapacity. A vibrant economy is one in which there is persistent labor
shortages that push up wages to reduce overcapacity. Private savings are needed
only for private investment that has no intrinsic social purpose or value.
Savings without full employment are deflationary, as savings reduces current
consumption to provide investment to increase future supply, which is not
needed in an economy with overcapacity created by lack of demand, which in turn
has been created by low wages and unemployment.
Say's Law of supply creating its own demand is a very special situation that is
operative only under full employment with high wages. Say's Law ignores a
critical time lag between supply and demand that can be fatally problematic to
the cash-flow needs in a fast-moving modern economy. Savings require interest
payments, the compounding of which will regressively make any financial scheme
unsustainable. Religions have forbidden usury for very practical reasons.
The relationship between assets and liabilities is expressed as credit and
debt, with the designation determined by the flow of obligation. A flow from
asset to liability is known as credit, the reverse is known as debt. A creditor
is one who reduces his liability to increase his assets, which include the
right of collection on the liabilities of his debtors. Sovereign debt is a
pretend game to make private monetary debts denominated in fiat money tradable.
The sovereign state, representing the people, owns all assets of a nation not
assigned to the private sector. This is true regardless whether the state
operates on socialist or capitalist principles. Thus the state's assets are the
national wealth less that portion of private sector wealth after tax
liabilities, plus all other claims on the private sector by sovereign right.
High wages are the key determinant of national wealth. Privatization generally
reduces state assets while it may increase tax revenue. As long as a sovereign
state exists, its credit is limited only by the national wealth. If sovereign
credit is used to increase national wealth, then sovereign credit is limitless
as long as the growth of national wealth keeps pace with the growth of
When a sovereign state issues money as legal tender, it issues a monetary
instrument backed by its sovereign rights, which includes taxation. A sovereign
state never owes domestic debts except by design voluntarily. When a sovereign
state borrows in order to avoid levying or raising taxes, it is a political
expedience, not a financial necessity. When a sovereign state borrows, through
the selling of sovereign bonds denominated in its own currency, it is
withdrawing previously issued sovereign credit from the financial system. When
a sovereign state borrows foreign currency, it forfeits its sovereign credit
privilege and reduces itself to an ordinary debtor because no sovereign state
can issue foreign currency.
Dollar hegemony prevents all states beside the US from financing their domestic
development with sovereign credit.
Government bonds act as absorbers of sovereign credit from the private sector.
US government bonds, through dollar hegemony, enjoy the highest credit rating,
topping a credit risk pyramid in international sovereign and institutional debt
markets. Dollar hegemony is a geopolitical phenomenon in which the US dollar, a
fiat currency, assumes the status of primary reserve currency in the
international finance architecture.
Architecture is an art the aesthetics of which are based on moral goodness, of
which the current international finance architecture is visibly deficient. Thus
dollar hegemony is objectionable not only because the dollar, as a fiat
currency, usurps a role it does not deserve, but also because its effect on the
world community is devoid of moral goodness, because it destroys the ability of
sovereign governments beside the US to use sovereign credit to finance the
development their domestic economies, and forces them to export to earn dollar
reserves to maintain the exchange value of their own currencies.