My title for today’s E-Letter probably sounds a little strange. What does the fact that China is unloading US debt have to do with what happens after Donald Trump? Answer: Nothing, really. Those just happen to be the two topics I landed on for today.
China is the largest single-country holder of US Treasury debt on the planet. But it has been regularly selling off its US debt holdings over the past few years in an effort to support its currency, the Chinese yuan. According to Treasury Department data released in September, China’s holdings of US debt fell to $1.22 trillion this summer, the lowest level in three years, and have continued to decline.
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The question is, what happens if China continues to liquidate its holdings of US debt? Answers are all over the board, ranging from very serious ramifications to not a whole lot. While the mainstream media would have us believe this could lead to another financial crisis, I’ll argue just the opposite today.
The other issue as it relates to China is that its national debt is now by far the largest in the world. You might have assumed that the United States’ gargantuan national debt of $19.7 trillion is the highest on the planet. Nope: China’s national debt is now estimated at $28.5 trillion – in an economy that is only about 60% as large as the US. I’ll explain that too.
Finally, I haven’t focused too much on the presidential election this year (as compared to previous elections). Yet it’s looking more and more likely that Hillary Clinton will be our next president, as much as I hate to admit it.
The question is, what will happen to Donald Trump and, more importantly, his enormous national following if he loses on November 8? I don’t pretend to know what Trump will do if he loses, but I don’t think his vast base of supporters will simply go away. I’ll offer some possibilities today that you may find very interesting depending on your point of view.
Let’s see if I can string these two very different issues together in another interesting E-Letter.
China Effect: Putting the Global Economy into Perspective
Whenever I decide to tackle a subject as complicated as this one, it’s always difficult to know where to begin, especially when the media has made the problem look much worse than it really is. In this case, China is reducing its holdings of US Treasury debt, and we need to figure out if that is a big deal or not.
Let’s begin by looking at the relative sizes of the economies in question. The US economy, as measured by Gross Domestic Product (the sum of all goods and services produced in the last year), was estimated at $18.6 trillion at the end of last year, the largest in the world.
The combined European Union economy is estimated at apprx. $16.5 trillion. Yet because the EU consists of 28 member states, it is not considered to be a single country.
With a population of almost 1.4 billion people, China is the second largest single-country economy in the world with GDP of apprx. $11.4 trillion as of the end of 2015. Japan comes in a distant third at $4.7 trillion followed by Germany at $3.5 trillion, according to figures released last week from the International Monetary Fund.
Again, in terms of perspective, we should look at the national debt of the largest economies in the world. Most experts agree that China’s national debt is 250% of its GDP (as compared to the US at 106% of GDP). If so, this means that China’s national debt is now north of $28 trillion, making it the largest debtor nation on the planet.
Most Americans have no idea that China’s national debt is larger than that of the US. Admittedly, China’s national debt is very difficult to determine since it is a state-controlled economy in which the government owns and/or controls over 50% of all corporations and banks.
I should point out that China’s national debt includes not only the government’s sovereign debt but also that of state-owned/controlled entities. The US national debt, on the other hand, only includes Treasury and related obligations.
Nobody really trusts China’s government statistics. But whether China’s national debt is $20 trillion or $30 trillion, that is HUGE! There is broad agreement that China’s debt is 250% of GDP compared to 106% in the United States.
China’s National Bureau of Statistics reported last week that the economy grew by 6.7% (annual rate) in the 3Q, the same as in the 1Q and 2Q. For years China’s economy boomed at annual rates of 10% or more, but it has steadily declined to the current level in recent years. Some economists around the world are skeptical of the 6.7% GDP number and argue that it could be more like 4-5%.
China Dumping US Debt: Why & Does it Really Matter?
China is the largest foreign holder of US Treasury debt and has been for a number of years. Its holdings of US Treasury bonds, notes and bills peaked at apprx. $1.32 trillion in late 2013. Since then, however, China has been reducing its holdings of US debt. In July of this year, China’s holdings of US Treasuries fell to $1.22 trillion, the lowest level in three years.
China further reduced its Treasury holdings to $1.18 trillion in August. We can also see in the chart above that China has also reduced its foreign exchange reserves since the middle of 2014, although that level has remained more or less stable this year.
Foreign-exchange reserves are money or other assets held by a central bank or other monetary authority that it can use to pay its liabilities, if need be, including the currency issued by the government. China’s foreign exchange reserves have declined from just under $4 trillion in mid-2014 to $3.2 trillion at the end of July.
Most currency analysts agree that China is reducing its holdings of Treasuries to generate US dollars which it can use to buy yuan (renminbi) and support its exchange rate. The same is true for the decline in China’s foreign exchange reserves, which it can also use to support its currency.
As you can see in the chart below, the Chinese yuan has been declining against the US dollar since late 2013, which coincides with the sales of US Treasuries and the decline in China’s foreign exchange reserves.
Other countries have been net sellers of US Treasuries this year including Japan, France, Brazil and Colombia. For the first six months of this year, foreign central banks sold a net $192 billion in US Treasuries. That was considerably higher than sales over the same period one year ago but the number is relatively insignificant.
Yet the Treasury reports that demand for US Treasuries has skyrocketed this year. Despite all the selling by the countries noted above and others, demand is so high that the US continues to pay historically low interest rates on its debt. The 10-year Treasury note hit a record low of 1.34% earlier this year but has bounced back to around 1.7% – still comfortably below 2%.
The benchmark 10-year Treasury yield is the thing you want to watch next time you read or hear stories about China or others “dumping” US debt. In most cases, these sellers are doing so in an effort to support their currencies and not because they lack faith in the US government.
China Bank Stress Indicator Rises to Dangerous New Record
I cautioned above that China has the largest national debt of any country at apprx. $28.5 trillion. That alone is more than enough to cause grave concern. In addition, a warning indicator for banking stress rose to a record in China in the 1Q, underscoring risks to the nation and the world from a rapid build-up of Chinese corporate debt.
China’s “credit-to-gross domestic product gap” stood at 30.1%, the highest for the nation since records have been kept (1995), according to the Bank for International Settlements in Basel. Readings above 10% signal elevated risks of banking strains, according to the BIS, which released the latest data on October 16. China is at triple that level!
The gap is the difference between the credit-to-GDP ratio and its long-term trend. A blow-out in the number such as we see below can signal that credit growth is excessive and a financial bust may be looming.
One reason the stress indicator is so high is that China’s largest banks are loaded with bad loans. Some analysts argue that China will need to recapitalize its banks in coming years because of bad loans that may be even higher than the official numbers.
The bottom line is that we don’t need to fret over China unloading US Treasuries. We do need to worry about a new financial crisis stemming from China’s largest banks that are awash in bad loans.
What Will Millions of Trump Supporters Do After November 8?
If the polls are to be believed, it currently looks like Donald Trump will lose on Election Day, although anything can happen over these last two weeks. Remember that Ronald Reagan was way behind Jimmy Carter at this point in 1980, but then won in a landslide on Election Day. Of course, Donald Trump is no Ronald Reagan.
Over the course of this campaign, Trump has won the hearts and minds of millions of hard-core supporters across the country. Do the “NeverTrumpers” believe that Trump’s faithful will return to business-as-usual on November 9, and that most of them will remain in the Republican Party?
Some will. But I fear that millions will not. Where do they go? That depends on Trump.
Trump said in the third presidential debate last week that he may not accept the election results – “I’ll keep you in suspense….” Yet there’s very little he can do about it unless there is evidence of significant voter fraud.
Some believe that if Trump loses on November 8, he will announce that he will run again in 2020. This is pure speculation, and I really doubt that he would run again at the age of 74.
Then the question is, who could step in and try to salvage Trump’s millions of fervent supporters and what’s left of the Republican Party? Some think it will be House Speaker Paul Ryan. I can’t see Trumpsters coalescing behind Ryan.
Some think it will be Ted Cruz. I don’t see that either. Cruz’s “vote your conscience” speech (meaning it’s OK to vote for Hillary) was suicide for him with Trumpsters. FYI, former Texas governor Rick Perry is reportedly considering challenging Cruz for his Senate seat. While I’m not a big Perry fan, I think he can beat Cruz.
Could it be someone like Rand Paul? Possibly, he did not alienate Trump supporters. But that’s not enough to become the GOP leader.
Or could it be someone like former Secretary of State (George W. Bush Administration) Condoleezza Rice, my personal favorite. She’s really smart, really conservative and is a pro-life Christian. She would be perfect to run against Hillary in 2020. The question is, would she have any interest? I don’t know.
The Republican Party could be in shambles if Trump loses. The GOP desperately needs to find a way to keep the millions of loyal Trump supporters engaged. If it allows them to simply fade away in disillusion with the “rigged system,” the GOP will miss a monumental opportunity.
Hopefully, Donald Trump is already thinking about this and is making a plan to keep his millions of supporters engaged politically beyond this year’s election.
Finally, Debi and I have entertained two groups of Millennials at our home on Lake Travis outside Austin over the last month. Our two kids (ages 22 and 26) often bring large groups of their friends to our family compound for a weekend on the lake. I feed them like kings!
On these latest two gatherings, I made sure to ask the groups at our Saturday evening dinners how they feel about this year’s election. Without exception, they are HOPPING MAD!
For most, this will be their first election to vote, and they could not be more disappointed with the choices they have. I can’t blame them – so am I! Nevertheless, I strongly encouraged them to vote, even if they write-in someone.
I encourage you to do the same. In that regard, please read the first link in SPECIAL ARTICLES below.
Very best regards,
Gary D. Halbert
Hillary Clinton & Donald Trump’s “Supreme” Difference (must read)