The China-US Ponzi Scheme

07/23/2009 9:31 am EST

Focus: MARKETS

Jon Markman

Editor, Trader's Advantage

Jon Markman, contributor to MSN Money, says the US and China have a co-dependent relationship, and that may lead to tears down the road.

What's so Ponzi about the Chinese-US relationship? Basically everything.

The [artificially low] renminbi made it irresistibly inexpensive for US companies to manufacture goods in China, even after shipping costs. As more companies shifted their operations to China, the US manufacturing base was hollowed out. Americans who once enjoyed high-paying factory jobs moved on to lower-paying service jobs.

China bought Treasury bills with its factory profits. The purchase of all those bills drove down US interest rates. As middle-class and blue-collar Americans saw their wages stagnate or decline, they discovered they could still keep their old lifestyles by borrowing.

As long as China kept buying [US paper], our driveways filled up with cars and boats, shopping malls spread out across the suburban landscape, and the retailer with the closest ties to China, Wal-Mart Stores (NYSE: WMT), became the US's largest company.

Was that so bad? Well, disgraced financier Bernie Madoff's clients for years thought they were rich because he sent them brokerage statements that said so. But that scheme worked only as long as new money kept coming in. When Madoff's $50-billion game fell apart, his victims suddenly discovered that their brokerage statements were worthless pieces of paper. The reality is that they were always broke; they just didn't know it yet.

The credit that has kept American families afloat for the past ten years is similar to those Madoff-produced brokerage statements. The credit is good only so long as China keeps recycling funds through the Ponzi scheme. But if Beijing leaders ever decide that it's just too risky to own US dollars and debt, then the system is going to come crashing down.

It's a classic Catch-22. China's cache of US bonds isn't worth anything unless the bonds are sold. But selling them on any kind of scale will gut their value.

China and the US together built the most monstrous liquidity bubble in world history as each pursued what it believed to be logical self-interest without any regulator, such as a stern global central banker, telling them that they were on a path of mutually assured destruction.

There are no good solutions. The Chinese need to open their markets and let their currency float on the open market, but they won't for political reasons. And the US needs to either halt its runaway deficit spending so that the world is not even more flooded with our debt, or swallow its pride and issue Treasuries denominated in Chinese currency. That probably won't happen, either. Which means there is only one solution left: a long, slow, boring, lonely, soul-crushing process of digging out from under the piles of debt that got us into this mess.

You might even say that the bursting of the credit Ponzi scheme has left us all in jail now with Madoff. Let's hope that our sentence is shorter than his.

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