Sep

14

It is debate season and high school debate students nationwide are researching and debating public health aid to Sub-Saharan Africa. I write articles and give talks on the economics of each year's debate topics, and on Tuesday spoke to some 500 students and teachers at the Kansas State Fair. I was providing economic comments after a series of demonstration debates.

Debaters on the negative in one round ran a off-topic China DA, that is, a China Disadvantage. They argued that the affirmative's plan for Africa would cost billions and those extra billions added to the current deficit would push the U.S. economy over a cliff. The "brink" would be that the extra debt would cause China to sell its holdings of US debt which would wreck the U.S. economy and lead directly to global thermonuclear war.

The strategy for debaters is to link the affirmative's plan with unintended consequences so terrible that the judge should vote negative just to be safe.

I commented mostly on other issues covered in the debate, but spoke briefly on the China DA. Thousands of top high school students attend debate camps each summer, and they all learn market-failure arguments, so if any Daily Speculations readers have responses to the ongoing "China could destroy the U.S. economy" fears please add your comments. I will promote them to the high school speech and debate community.

Here is what I said: Could China destroy the U.S. economy by selling all or most of its U.S. debt holdings? No. The Chinese government can try to sell large quantities of U.S. Treasury bonds, but who would buy them? If the Chinese government tries to sell too many, "dumping" them on the bond market, the price of these bonds would likely fall. The cheaper the bonds are to purchase, the higher their effective yield, so the more attractive they become. These are bonds already issued and each provides a fixed interest rate that the U.S. government has promised to pay over the life of the bond. The Chinese government has already purchased these bonds. When they are sold on secondary markets that doesn't change U.S. government obligations.

Natural market processes dampens erratic moves in markets. When investors are spooked for some reason (say, for example, by negative reporting by journalists and bears seeped in market-failure ideas in college), and the price of stocks falls, the further bond prices are pushed down, the more attractive the stocks look to other investors. Dividends look more attractive when stocks are cheaper and lower stock prices don't directly hurt company earnings, so investors are drawn to the stock to capture dividends or expected future appreciation or both.

When bond markets are spooked and scared investors sell bonds, prices similarly fall and effective interest rates paid rise. Again, if the Chinese or Japanese (who hold more U.S. debt than the Chinese according to the U.S. Treasury), sold large amounts this could indeed start a brief "panic". But what "panic" selling means to the media is not what it means to the market. Even small dips in bond prices and small upticks in yields are big news. The idea that a U.S. bond-selling contagion could grip the world and push prices down dramatically is like pushing an object toward the speed of light, it takes dramatically more energy as you get close to limits, and infinite energy to push bond prices to zero.

And the worst case scenario: interest rates for U.S. Treasuries rise significantly. That makes it more expensive for the U.S. to issue new debt, that is, harder for the U.S. government to borrow more money to waste on building bridges to nowhere and thousands of other pork-barrel earmarks. Higher interest rates would encourage the U.S. government to spend less and borrow less. And that would not be a bad thing.

So, these are were my general comments on the "China DA." If Daily Speculations readers and writers have further comments, observations, and insights that might help students better understand financial markets, please post them.


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