Of the big-3 credit rating agencies, only the S&P rating agency had the courage and fortitude to speak the truth, about the severe deterioration of America’s financial status. S&P shocked the political establishment in Washington, by following through with its threat to downgrade US Treasury debt to AA+ on the evening of August 5th. S&P added that the US Treasury debt could be downgraded further, if the crooked and inept politicians in Washington haven’t taken any meaningful moves to cut the size of its mounting debt.
Yet the most important voice in the debate about the credit worthiness of America’s debt, is not the twisted opinions of the US-credit rating agencies, but rather, that of China’s credit rating agency - Dagong Global Credit Rating, which downgraded US-Treasury’s debt from A+ to single-A last week. “The US decision to raise the borrowing ceiling will not change the fact that the growth of its debt has outpaced its overall economic growth and fiscal revenue. “It may further erode the country’s debt paying ability in the coming years,”Dagong Global said. It also issued a negative outlook. “The rise of the US-debt ceiling helped temporarily avoid a debt default but has not improved its solvency and the increasing government debt burden will deteriorate the US sovereign debt crisis.”
Beijing has earned the right to criticize the US-government’s addiction to debt, since it’s the biggest foreign holder of US Treasury notes, and it’s much better at managing state finances.China posted a fiscal surplus of 1.25-trillion yuan ($193-billion) in the first half of the year as steady economic growth lifted government revenues, the Ministry of Finance said on July 14th. The budget surplus, equal to about 6.1% of China’s gross domestic product from January to June, is well above Beijing’s target for a full-year fiscal deficit of 2% of GDP.
For most of the past decade, Beijing has been a loyal creditor of the US Treasury, recycling more than $2-trillion of its foreign currency holding into US-dollar denominated bonds, thus helping to keep US-interest rates artificially low. For the most part, US Treasuries represent the only destination large enough to accommodate China’s vast holdings, and that can absorb a trade in the tens of billions of dollars of T-notes, without moving prices too far. However, in a shocking development, Beijing has suddenly decided to take a very hard-line with the US Treasury, and is openly calling upon Washington to “cure its addiction to debts and learn to live within its means,” before it resumes lending to the US-Treasury.
In a commentary published by the China News Agency on the evening of August 7th, the technocrats in the Politburo dropped the equivalent of a nuclear bombshell that ignited a worldwide meltdown in global stock markets and sent gold soaring above $1,700 /oz. “China, the largest creditor of the world’s sole superpower, has every right to demand the US to address its structural debt problems and insure the safety of China’s dollar assets. If no substantial cuts were made to the US’s gigantic military expenditure and bloated social welfare costs, the latest credit downgrade would prove to be only a prelude to more devastating credit rating cuts, which will further roil the global financial markets all along the way,” it said.
That report followed by another editorial published by the China News Agency on August 6th. “Dagong Global degraded the US Treasury bonds late last year, yet its move was met then with a sense of arrogance and cynicism from some Western commentators,” the New China News Agency’s Saturday editorial said. “Now S&P has proved what its Chinese counterpart has done is nothing but telling the global investors the ugly truth.”
On August 8th, Beijing shocked the markets again, in a stinging commentary carried by the official Xinhua news agency. “China has every right to demand the US address its structural debt problems and safeguard China’s dollar assets. Washington needs to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone. To cure its addiction to debts, the US has to re-establish the commonsense principle that one should live within one’s means,” Xinhua said.
Fears that Beijing is preparing for a confrontation with Washington sparked widespread selling in Asian stock markets on August 8th, and sent the price of Gold soaring above $1,700 /oz for the first time ever. A former top official of the National People’s Congress, Cheng Siwei said in an interview that Beijing should use future foreign reserves to buy bonds of other countries, instead of buying US Treasuries. “In my opinion, in regards to US Treasuries, the best strategy is no buy, no sell. I think maybe that’s the best strategy,” Cheng said.
The S&P rating agency was attacked in the media by the US Treasury chief and several mutual fund managers who were caught with their pants down, and left holding large positions in the stock market. When panic selling set in, the Dow Jones Industrials plunged -634 points on August 8th, its sixth worst point loss in history. That followed on the heels of the Dow’s eighth worst daily decline on August 4th. S&P-500 stocks lost -15% of their value in just two and a half weeks, while the Russell 2000 Index fell into bear market, down -25% from its April 29th high. The finger of blame for the market turmoil should be pointed at the crooked politicians in Washington that have buried America deep in debt. Nobody should be surprised, that the US’s #1 lender - Beijing, would threaten to cut-off the credit lines.
There were early warning signals of big trouble for the US stock market, that were ignored by the snake oil salesmen on Wall Street, who continue to tout investing in the stock market. However, contrary to bullish expectations, US-factory activity began to contract sharply in the month of May. The stock market bulls said the drop was temporary, - related to Japan’s tsunami. There was an explosive stock market rally in the last week of June, with bullish traders intoxicated under the influence of QE. Yet the last gasp rally was a bull trap, - the completion of a classic a “Head & Shoulders” topping pattern. Once the S&P-500 Industrials collapsed below the “neckline,” – panic selling ensued.
Stock market bulls are heavily addicted to the Fed’s hallucinogenic QE-drug, and soon after the Fed stopped injecting the heroin on July 1st, severe withdrawal symptoms began to take effect. Undoubtedly, the Wall Street Oligarchs, and their clients - the 10% of the wealthiest Americans who own 80% of the US-stock market, will be calling on “Bubbles” Bernanke to exercise the infamous “Bernanke Put” – that is to say, flooding the system with another tidal wave of cheap money in order to bailout gamblers when risky bets that go sour.
QE is nothing more than a “bargain with the devil.” The problem is that cheap borrowing costs also make a fertile environment for bubbles, which eventually will burst. Speculators borrow cheaply and make even bigger bets in the stock market. “The effort to help the economy sets up another more dangerous bubble,” warned Jeremy Grantham, chief investment strategist at Grantham Mayo Van Otterloo on October 27th, 2010. “It seems certain that the Fed is aware that low rates and moral hazard encourage higher asset prices and increased speculation, and that higher asset prices have a beneficial short-term impact on the economy, mainly through the wealth effect. It’s also probable that the Fed knows that the other direct effects of monetary policy on the economy are negligible,” he said.
“In almost every respect, adhering to a policy of low rates, employing quantitative easing, deliberately stimulating asset prices, ignoring the consequences of bubbles breaking, and displaying a complete refusal to learn from experience has left Fed policy as a large net negative to the production of a healthy, stable economy with strong employment,” Grantham wrote in a report titled “Night of the Living Fed.”
Fed policy has resulted in “extraordinary destructiveness and ruinous cost. I would force the Fed to swear off manipulating asset prices through artificially low rates and asymmetric promises of help in tough times,” - the Greenspan/Bernanke Put. “It would be a better, simpler, and less dangerous world, although one much less exciting for us students of bubbles,” Grantham added. Indeed, for the past decade, stimulating the US-economy has based upon blowing one bubble after another. Once the Fed stopped the daily injections of QE on July 1st, the QE-2 bubble on Wall Street began to burst spectacularly, and led to the loss of $3.8-trillion of paper wealth worldwide.
It’s only been five weeks since the Fed finished its $600-billion QE-2 scheme, and already, jittery mutual fund managers on Wall Street are crying for help. However, on August 7th, China’s Foreign Minister Yang Jiechi, warned US President Obama that the Fed mustn’t be allowed to launch another round of money printing that could crush the value of the US-dollar. “We also hope the United States can adopt measures to insure the safety of assets in the US held by other countries. The economic trend in the US has a significant impact on the global economy. A stable value of the US-dollar, as a major global reserve currency, is very significant to global economic and financial conditions,” he said.
Over 60% of China’s foreign currency stash is believed to be in US-dollar assets. Apart from Treasury bonds, China holds hundreds of billions in mortgage-backed securities issued by Freddie Mac and Fannie Mae, and corporate equities and bonds. The dollar assets held by China are now believed to total $2-trillion. It is estimated that in the first four months of 2011, China’s invested three-quarters of its foreign currency surplus in non-US dollar assets. As a result, China is vulnerable to the demise of the US-dollar, but also the European debt crisis that threatens the existence of the Euro as a unified currency.
The People’s Bank of China (PBoC) still hasn’t been able to get the country’s inflationary spiral under control. The consumer price index was reported +6.5% higher in July from a year ago, it’s fastest in three years. Beijing is laying the groundwork for another quarter-point rate hike in the weeks ahead, by guiding China’s 1-year T-bill rate to 3.80%. Another round of QE-3 in the US would force Beijing to print vast quantities of yuan in order to prevent a collapse of the US-dollar, which in turn, could fuel even faster inflation in the Chinese economy. In that case, the PBoC would be forced to hike short-term interest rates much more aggressively, - thus risking the chance of toppling the world’s economic locomotive into a “hard landing.” Already, there are signals that China’s vast factory sector is stalling out, and the Shanghai red-chips have tumbled into bear market territory.
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