Imagine becoming so successful at your job that you stack up $2 trillion in income, which you conservatively place in short-term U.S. Treasury bonds for safekeeping.
Now imagine that when you try to cash in those bonds to buy a few things for your kids, the clerk at the bank abruptly shuts her window and tells you to go away.
That is essentially the situation faced by China these days as it wonders whether its plan to manufacture goods for U.S. consumers over the past two decades in exchange for a pile of credit slips was really such a hot idea.
The answer is coming up as a big, fat "uh-oh" as the U.S. deficit and debt obligations balloon to levels never before contemplated, and Beijing is denied requests to buy U.S. and Australian mines and oil properties. And as Beijing leaders talk openly, if obliquely, about their angst, they are unsettling world credit, currency and stock markets, which don't know what to make of the idea that the world's largest Ponzi scheme might be coming to an abrupt end.
This is a good time to assess the chilling possibilities, as the resolution of this pending crisis will afflict investors, workers and business owners alike.
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Dangerous symbiosis
What's so Ponzi about the Chinese-U.S. relationship? Basically everything. Look at it this way:After a currency debacle in 1998 left its economy in tatters, Beijing decided to radically restructure its financial relationship with the West. Policymakers pegged the value of China's currency to the dollar, which had the effect of keeping it artificially low.
The cheap renminbi made it irresistibly inexpensive for U.S. companies to manufacture goods in China, even after shipping costs. As more companies shifted their operations to China, the U.S. manufacturing base was hollowed out in the name of globalization and profitability. Americans who once enjoyed high-paying factory jobs moved on to lower-paying service jobs.
China didn't need much of anything made in America, so instead of buying cars from Detroit and furniture from North Carolina with its factory profits, it bought Treasury bills. The purchase of all those bills drove down U.S. interest rates. So as middle-class and blue-collar Americans saw their wages stagnate or decline, they discovered they could still keep their old lifestyles by borrowing.
Over the past decade, Americans were able to outspend their incomes by easily rolling their debts forward through serial home refinancing. The situation was never ideal, but it worked as long as the value of their collateral -- their homes -- kept rising.
As long as China kept buying Fannie Mae (FNM, news, msgs), Freddie Mac (FRE, news, msgs) and Treasury credits, the scheme worked in a strange and beautiful way: 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 (WMT, news, msgs), became the United States' largest company.
Land-mine economics
Was that so bad? Well, now think about this in the context of a Ponzi scheme such as the one perpetrated by disgraced financier Bernie Madoff.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 international money flows seized up last year and too many people wanted to redeem their accounts at once, Madoff's $50 billion game fell apart. Then his victims suddenly discovered that their brokerage statements were worthless pieces of paper. Madoff clients' households crashed, and now one-time millionaires are broke. The reality is that they were always broke; they just didn't know it yet.
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