Picking An Economic Fight With China Is A Risky Move
-- September 8, 2003

Behind the scenes of a buoyant stock market lie serious problems for the US financial system.

The federal budget deficit is soaring out of control. At the same time, the US balance of trade is bleeding red ink. The combined deficit from these two factors could approach 7% of total US gross domestic product by year end -- by far the highest level in history. That means that the US is going deeply into debt at the same time that we're shipping more and more of our wealth overseas. This is a dangerous combination.

Meanwhile, the job market is going from bad to worse. The only reason that unemployment isn't going up is more and more workers are dropping out of the workforce. Companies are slashing payrolls by shipping the high-paying jobs overseas -- to places like China.

This brings us to Treasury Secretary John Snow's visit to Asia last week. His goal was to get China to agree to revalue its currency. The theory is that if China revalues, the US can export more goods and close the trade gap. Don't believe it. The problems on the trade front run much deeper than that.

The relationship between the US and China is complementary and complicated. In essence, the Chinese send us lots of goods and we send them lots of dollars. They in turn take those dollars and buy lots of US Treasury and agency bonds.

China and the rest of Asia own an incredible amount of US Treasuries -- about $696 billion in Treasuries at the end of June, up from $512 billion in December 2001, according to data from the US Treasury. So the US administration has to be careful about pushing China too hard. Reason: If China decides to sell some of its massive holdings -- or even just stop buying US Treasuries by the bucketload -- it could drive US interest rates sharply higher and the dollar sharply lower. And that would be bad news for consumers and the stock market.

So, if the US ups the ante with China, it could be time for investors to head for cover -- stay tuned.

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