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The Daily Reckoning

Why China dumping US debt could be great for America

If there wasn't a market for its debt, the US would have to address its spending addiction.

By Rocky VegaGuest blogger / March 5, 2010

If China was to turn off American access to credit – a symbolic cutting of the credit cards, as seen here – the US would have to deal with its addiction to debt.

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Providing the world’s reserve currency has its privileges. Not the least of which is the continued willingness of foreigners to soak up the massive amounts of debt issued by the US despite the nation’s continued debasement of the dollar.

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Yet, what if the foreign nations stopped buying? We’ve certainly heard of the calamity that should result from China cutting the US off, but perhaps we shouldn’t be so certain that’s the case.

Let’s suppose for a minute that it’s not. Mike Cosgrove investigates an eye-opening upside of a US without a market for its debt.

From Investor’s Business Daily:

“The Chinese and Japanese are our friends for two reasons: (1) Their net purchases help keep bond yields low, and (2) Chinese warnings about not buying more Treasuries or in fact selling Treasuries can send shock waves through capital markets.

“Congress and the Obama administration don’t seem overly concerned with huge federal deficits. But the administration does understand the crisis that would be created in capital markets were the Chinese to become net Treasury sellers, even for a short period of time.

“The Chinese can act as a constraint on the reckless federal spending of Congress and the administration. In fact, the Chinese may be the only realistic constraint in 2010…

“…The Chinese can lecture the administration about excessive federal outlays, but nothing would be more effective than dumping Treasuries, even for a short time. Such action would panic investors, and as a result the administration may well agree to constrain spending to placate the Chinese.”

In the scenario Cosgrove plays out, China has the potential to act like a caring relative who, familiar with the Alcoholics Anonymous process, is ready to perform an intervention. It’s hardly a painless process, but perhaps the US debt market needs to hit rock bottom before the administration will walk the road to recovery.

You can read more about Cosgrove’s theory in an Investors.com editorial on why the Chinese can’t dump our debt too soon.

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