The Debt Cycle

So, it’s a well-known fact that the US and China have been buddies as far as trade relations go. The two are neigh inseparable…. quite literally as you’ll soon find out. But how did these two massive economies get this intertwined? How did everything begin and most importantly why can’t they separate even if they wanted to?

Make Way for CHINA!! *toot toot*

Our story starts in the 1950s. An age when my parents were born, people watched silent films and hunted dinosaurs. Oh not to mention there wasn’t any Facebook or Instagram. Yes you heard me, hipsters of the world. No. Instagram.

China was a land of famine and hardship. Most Chinese children were 4 inches shorter than the world average. The protagonist of this story is one Deng Xiaoping. He believed in a rich, prosperous and well a generally better China than what it was at that point of time. #policytime

The crux of his policy was to devalue the Chinese currency (Yuan) to ensure that Chinese exports became cheaper. This effectively raised the demand for Chinese exports thus allowing China to earn a humongous amount of foreign currency. Over time due to this massive inflow of foreign exchange, China soon had the largest foreign exchange reserves in the world. (For the nerds, 1 Trillion dollars in 2009). Because of these astronomical figures, and the large opportunity cost incurred by holding onto this large forex reserve, China was on a look out for a bank to keep it in.

Hong Kong

US comes into the picture

OK listen up kids, this is where things get interesting. Ever after the Cold War with the US gaining their superpower status, their consumption levels have sky rocketed way beyond their own economy can sustain. This lead to a large amount of importing of conveniently cheap Chinese exports. This lead to a huge outflow of USD to China in order to pay for these imports. Over the years, this outflow increased with no signs of tampering off. The US economy at this point desperately needed money in order to pay for its imports as their economy could not support such expenditure. As a result the Federal Reserve issued government backed bonds.

It important to know that owing to USD being the world’s most demanded currency (international oil trade) and the US having the status of a superpower (thus having an enormous amount of investor confidence) US bonds have and still remain to be the most secure type of investment anyone can make. Therefore say you had 1 Trillion USD on your hands and wanted to bank it, this would be the perfect safe. And that’s exactly what China did.

Drum roll PLEASE!!!

And that ladies and germs is exactly how a bulk of international trade works. The low exchange rate of the Yuan keeps the US as a loyal customer of Chinese exporters. The US (financed by their bonds i.e. Chinese money) buys Chinese exports thus increasing Chinese forex reserves. These reserves are diverted to US bonds and so the cycle starts again.

It’s estimated that as much as 1.5 trillion Chinese owned USD now back and support the entire US economy.

As you can see, the Chinese obviously have the US in their hands. So given their obvious hate and non-cooperation with the US in every other matter apart from trade, why not just pull the plug on their money in US bonds and ask for the lot back?

Well my little Chimichangas it’s a wee more complicated than that. If the China was to ask for a total or majority recall of their money when these bonds matured, the first effects would be a complete and utter collapse of the US economy and government. This would pull the whole world into a massive recession, one much bigger than all previous ones added up. In addition to this, an act like that would leave China with a shit load of USD (which would be worthless because the US economy is nonexistent). Thus the added headache of needing to put that money into some other form of security which would be neigh impossible since the rest of the world and it’s currencies would also lose value due to the recession.

Secondly, this would trigger a sharp fall of Chinese exports over the next year as economies everywhere continue to crumble. Soaring unemployment rates, low wage rates and complete economic instability would just be the tip of the iceberg for all economies including China. Following the recession and obliteration of economies, soon political systems and governments would fall thus leaving the world in a state of anarchy and lawlessness.

We would effectively be hauled back kicking and screaming to the dark ages in a matter of years if not months. All our efforts to become “civilized” would be wiped out in a blink of an eye.

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