The larger lesson from Geithner’s China trip

posted at 11:34 am on June 2, 2009 by Karl
printer-friendly

Treasury Secretary Timmy Geithner went to China this week to reassure folks that China’s huge holdings of dollar assets are safe. A student audience at Peking University laughed at him. Yu Yongding, a former central bank adviser, told Bloomberg that “[i]t will be helpful if Geithner can show us some arithmetic,” as though Geithner was a remedial student.

China (and other holders of Treasury debt) are uneasy because the Fed’s quantitative easing program seems ineffective. The Fed created a trillion dollars out of thin air in March to purchase Treasury bonds and mortgage securities, but the yield curve is steepening.

Will the Obama administration’s approach launch America into an inflationary spiral like Argentina? Or will all of that freshly printed money and self-purchased debt nevertheless fail to prevent a painful period of Japanese-style deleveraging?

I freely admit to not knowing enough about economics to know the answer to those questions. What I do know is that Fed officials are almost equally clueless in diagnosing the current state of the bond market:

The Federal Reserve is studying significant moves in the U.S. government bond market last week that could have big implications for the central bank’s strategy to combat the country’s recession.
But the Fed is not really sure what is driving the sharp rise in long-dated bond yields, and especially a widening gap between short and long term yields.

Do rising U.S. Treasury yields and a steepening yield curve suggest an economic recovery is more certain, meaning less need for safe haven government bonds and a healthy demand for credit? If so, there might be less need for the Fed to expand the money supply by buying more U.S. Treasuries.

Or does the steepening yield curve mean investors are worried about the deterioration in the U.S. fiscal outlook, or the potential for a collapse in the U.S. dollar as the Fed floods the world with newly minted currency as part of its quantitative easing program. This might be an argument to augment to step up asset purchases.

Another possibility is that China, the largest foreign holder of U.S. Treasury debt, has decided to refocus its portfolio by leaning more heavily on shorter-term maturities.

With officials still grappling to divine the factors steepening the yield curve, a speedy decision on whether to ramp up the Treasury debt purchase program or the related plan to snap up mortgage-related debt seems unlikely.

Yet the notion that the Fed and Treasury know what they are doing is the foundation upon which Pres. Obama’s economic program is built. Indeed, the conceit that statist bureaucracies of experts, left to their own devices, can steer the US economy to that third bowl of porridge that is neither too hot nor too cold, but just right, has been a tenet of progressivism since its inception. The real lesson of Geithner’s trip is that he had to make it. The response to his message reveals that even the People’s Republic of China has learned something about the limits of statist bureaucracies. Eventually, even the Obama administration may learn that lesson. America can only hope that lesson gets learned before the economy ends up in the wrong bowl of porridge.

Blowback

You must be logged in to post a comment.