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  • Mathieu Provencher

Economic Warfare!

I have a bit of a special topic for this time around: Economic Warfare! No I am not going to talk about the sanctions on Russia and their potential Economic impacts (and the potential retaliations Russia might get under way) and No I am not going to talk about Argentina's default (which has now happened), which I already predicted for you guys that just had a semester with me (and a few semesters before that as well, Argentina is a very interesting Economic experiment at the moment)...

I want to talk about an Economic weapon that the USA has been using for a few years now (in their recent history): Bonds. It has occurred to me around a year ago that the extreme borrowing the USA was making, by selling bonds (quite a volume to China) might be in fact Economic Warfare in disguise. Now... if I disappear in the next few days, you guys know I was on the right track (I hope this is going to be a joke between us and not an actual "coincidence").

Here's how bonds work: The Central Bank of a country (The Fed for the USA) can sell bonds to whomever wants them in exchange for money. In actual fact it can get more complicated than that but the idea stays true. The Government can then use that money to finance itself if it is short in liquidity, which then increases the debt of that government. Nothing too fancy so far, it just means that bonds can be used to borrow (one of its two possible uses)...

Now let's get in the concept at hand: The government might be selling these bonds because its economy is not doing very well. It wants the money to invest in different projects or just to have enough money to pay for its operations (in times of low economic activity, governments tend to receive less money), or both...

I can hear some of you saying that selling bonds will increase the interest rates (because of scarcity of money in the economy), which will then hurt the economy; students that remember well what we've seen together may recall that buying bonds is an expansionary policy, not selling. Economics is a bit more complicated that what we see in class together... In this case, it depends who buys your bonds. If, let's say, China buys your bonds (just choosing a country completely at random here... or am I) and pays them with all the extra trade surpluses they made over their years as a net exporter, then the money supply in your country will not decrease, it will even increase if the government re-injects that money in your country.

All right, you might say that everything is dandy and there doesn't seem to be any issue with any of that... and you would be right, for a time. After a while of these bond sales by the USA and these bond purchases by, let's say, China, you start having a very nice situation developing: interdependence. Since few people from the USA are buying these bonds (because of low economic activity) and most of these are bought from the outside (where economic growth is much higher), then the USA is effectively deploying their subtle Economic Weapon.

Here's how I see it: Countries will now rely more and more on the USA's economic situation because of two things: (1) they want the USA government to pay them interest on their huge piles of bonds and they certainly want to receive back the amounts they lent to them; (2) since these bonds are denominated in US dollars, they want the USD to stay strong in order to be paid back in a currency that is well accepted worldwide.

So China, for example, will loose a lot of money if the USA's economy crashes because of the risk of default on their bonds AND because of the depreciation of the US dollar (which is what they receive for these same bonds)... which makes it very risky to hurt the USA's economy for these countries that have purchased high amounts of bonds from that country.

As such, China is (partially) at the mercy of the USA's economy and it cannot "attack" it without incurring vast economic losses.

Selling mountains of bonds could in fact have been a sort of economic "shield" against potential economic "attacks" from its rivals. I have the impression that China and Japan realized that very very late and were already caught in that cycle of purchases of USA bonds before they could really do anything about it. These countries purchased bonds to support the USA's economy (to avoid their losses), which made them more vulnerable to that economy, which made the USA sell more bonds (they knew these countries would buy them), which made the other ones buy more, which made the USA sell more... etc.

With this unmovable peak of debt of the USA's government (which threatens the revenue of bond-holding countries), all countries that are stuck with all these bonds will have to accept a (substantial) partial default from the USA, which is where I think the next step of that strategy goes. It seems to me that the Economists of the USA's Fed were very smart in playing with their "rivals" and I salute their strategy (if it was indeed intentional). The significant economies of this time are now at the mercy of these individuals and will probably "accept" the terms of their monetary "reforms", well done boys!

It seems to me that the USA will probably fight very hard to keep their leadership of the world once Obama goes. I have the impression he is an objective, smart, and calm president, which doesn't go so well with the American people in general it would seem... If we get another Bush, we're really going to see an aggressive position on the debt repayment and on the bonds markets, which could very well, opposite to what the politicians want, bring down the USA even faster! Hey, maybe it's Peru's turn to rule the world now... or China, it's a tight match no?

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