The U.S. and China: A Duel to the Debt

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In this period of "exceptional uncertainty" (to quote Federal Reserve Chairman Ben Bernanke), where can investors turn for a considered perspective on the current environment? Produced to feed the beast of the 24-hour news cycle, the bulk of financial journalism and commentary today isn't worth the servers it is stored on. One notable exception to that rule is Buttonwood, the financial markets column of The Economist. Philip Coggan is the columnist -- arguably the most influential position in financial journalism (along with the head of Lex at the Financial Times).

Deciphering the headlines
With the developed world facing fiscal and monetary crises, Coggan's new book, Paper Promises: Debt, Money, and the New World Order, is a veritable enigma machine for investors who wish to decipher today's headlines (the U.S. edition was released Monday). In an email interview last week, Coggan shared his observations on some of the most pressing topics of the day. In the first of two articles, he explains why the current international monetary system is on its last legs and discusses the possibility of the Chinese renminbi replacing the dollar in a successor system:

"The thesis of the book is that economic history is a battle between creditors and debtors, with the nature of money the territory over which they fight. Money has two core functions; as a means of exchange (paying for your daily Starbucks) and as a store of value (making sure you can still afford a Starbucks in old age). Historically, those two functions have been in conflict; some groups have wanted to expand the supply to encourage economic activity; others have wanted to restrict the supply of money to protect the value of savings. Broadly speaking, the money expanders have been debtors and the money restricters have been creditors."

Debtors and creditors: a historical struggle
As he makes clear, that dichotomy is at the root of the rise -- and fall -- of different monetary systems:

"Over history, creditors have tended to impose systems that control the supply of money -- the gold standard, the Bretton Woods system of fixed exchange rates, the euro -- that prevent borrowers from repaying their debts in debased currencies. The strain of keeping up this discipline is intense in democracies where more people are debtors. The gold standard broke down in the 1930s, Bretton Woods in the 1970s and the euro is struggling today, as is what might be called the post-Bretton Woods system of independent central banks and inflation targets. A new world order will emerge from the ashes."

Today, the struggle between debtor and creditor pits the United States -- the world's largest debtor nation -- against rising superpower China. With more than $15 trillion in outstanding public debt, Uncle Sam is in hock to China to the tune of a cool $1.1 trillion. In light of these numbers and China's growing confidence, it's not hard to imagine that the relationship between the two nations will be instrumental in shaping a new monetary order. How fast will it emerge and how far will it go? Could we witness the renminbi (China's currency) replace the dollar as the world's reserve currency? I asked Buttonwood.

A long way behind
"Could we see the renminbi replace the US as the reserve currency in our lifetime? It depends on how long you think you will live. Reserve currency status is not just a matter of having the largest economy; it is a function of liquidity and trust in the legal system. In both cases, the renminbi is a long way behind. Remember that sterling was still being used as a reserve currency in the 1950s, 60 years after the US overtook Britain."

Nevertheless, the future stability of the dollar is at risk, as projected increases in unfunded liabilities related to Social Security and Medicare/Medicaid threaten to upend a delicate equilibrium that is based on trust and confidence. That problem -- serious as it is -- is compounded by a fractious political class that is unable (or unwilling) to address the problem in a mature manner. Since optimism is a trait of the American character, let's take a "glass half-full" approach. What are the reasons to believe that the U.S. can tackle its debt problem effectively? I asked Buttonwood.

Three hopeful signs
"The most hopeful signs for the US in dealing with its debt problems are threefold; demography, economic vitality and energy. America has a higher birth rate than Europe and (at the moment) benefits from lots of immigration. Whereas in Italy there are currently 3 people of working age for every pensioner, in the US there are 4.6. By 2050, there will be only 1.5 Italian workers per pensioner but the US will have 2.6, better than much of Europe today. Secondly, the US is in the forefront of new industries like software, biotechnology and alternative energy that could boost productivity in the future. Since economic growth is a function of a) worker numbers and b) productivity, both are positive news. Third, the recent development of shale gas makes the US much more energy sufficient than Europe."

The old continent: No question about it, Europe is in a real jam right now. In our concluding article, Buttonwood lays out one way in which the European sovereign debt crisis may play out and discusses whether a new gold standard would make a good replacement to the current regime of floating fiat currencies. Finally, he highlights the extraordinary shift by which orthodox thinking in the U.S. regarding the currency has been turned on its head -- stay tuned.

China may overtake the U.S., but three American companies are set to dominate the world.

Fool contributor Alex Dumortier has written for, The Economist's website. Click here to see his holdings and a short bio. You can follow him on Twitter. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (12) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 08, 2012, at 4:27 PM, DJDynamicNC wrote:

    People bemoan our regulations, but they are what give our dollar the cachet and stability to be the world's first choice of reserve currency. China simply doesn't (at this time) inspire anywhere near the same confidence, and won't unless we actively deregulate ourselves to their level.

  • Report this Comment On February 08, 2012, at 5:06 PM, TMFAleph1 wrote:


    China's economy/ currency is anything but unregulated! I assume you're referring to conficence based on U.S. property rights and the enforcement of the rule of law.

  • Report this Comment On February 09, 2012, at 1:37 AM, BBLBBD wrote:

    Some thoughts here:

    First, everyone wants to blame "political gridlock" or whatever for our problems. That seems to be code for "those stupid tea party morons won't let us increase government spending." Great. However, please acknowledge that government spending increases automatically every year. It is always increasing. A reduction in the increase is not really a cut.

    Second, there is a point about Chinese lending. How long will China lend us money so we can pay senior citizens their 30 paid vacation and trips to visit the peasants in China, or free medical care to fatties who eat more calories than a rural family in China, or to enrich moronic politicians so they can graduate to the "global citizenry" (Clintons).

    Last, everyone if fooling themselves on American demographics. The population increase comes from an illegally imported peasant class from Mexico and South America, who the left refuses to assimulate into our common culture. Who thinks their "multicultural" offspring will pick up the tab for the old fat American ?

    The problems in American are structural and they stem from the left.

  • Report this Comment On February 09, 2012, at 11:25 AM, TMFAleph1 wrote:


    Please acknowledge that the size of the U.S. economy increases every year (statistically -- not automatically.)

    Normalized for the GDP, a reduction in the increase in the size of government expenditures may very well be a cut. The problem is not government spending "increasing automatically every year", the problem is when government spending increases faster than the capacity to pay for that spending.

  • Report this Comment On February 09, 2012, at 11:35 AM, DJDynamicNC wrote:

    @TMFAleph - I'm sorry for being unclear. You're absolutely right in that China's economy and currency are far from unregulated. However, the "regulations" in question have not been implemented with the same goals as ours, nor the same methods.

    Whereas we have an SEC to enforce fair markets (however lackluster the performance has been lately) and an MSRB and FINRA and SIFMA and CFPB all geared with an aim towards creating open, fair, legally binding contracts in a free market environment with an active court system for redress of broken contracts, China lacks these and instead offers a rigidly controlled economic system based on patronage, lacking the transparency requirements and culture that we take for granted. Hardly an ideal investment environment.

    I wouldn't invest directly in China without a much deeper understanding of the specific businesses involved; I maintain exposure to Chinese growth through multinationals that I am familiar with and can properly understand and vet.

  • Report this Comment On February 09, 2012, at 11:39 AM, TMFAleph1 wrote:


    Yours is a prudent way to approach investing in China at this time.

  • Report this Comment On February 09, 2012, at 11:40 AM, DJDynamicNC wrote:

    @BBLBBD - "Last, everyone if fooling themselves on American demographics. The population increase comes from an illegally imported peasant class from Mexico and South America, who the left refuses to assimulate into our common culture. Who thinks their "multicultural" offspring will pick up the tab for the old fat American ?"

    If that is the problem, couldn't it be solved simply by opening the border up to legal immigration so that the illegally imported class could stop hiding and start assimilating? I'm not sure how you expect them to assimilate when we are openly at war with them.

    It's funny, because if a ton of people are trying to move from a city in Iowa to a city in California because of the jobs market, the Californian city is said to be "booming" and everyone thinks it's great. But if the exact same situation plays out but the source is a city in Mexico, suddenly it's "stealing American jobs."

    The bottom line is that sourcing factories in Asia to sell goods to Americans is a limited time trend and it is likely to become cheaper to source those factories in America again some time in the future, BUT companies will still be sourcing the majority of their factories in Asia simply to provide goods to Asia, if only because the vast majority of the world's population lives there. If we really want to compete we should take advantage of the fact that lots of people want to live here and trade labour for money. This is a huge asset that we are actively discouraging for irrational reasons.

  • Report this Comment On February 09, 2012, at 11:49 AM, talan123 wrote:

    China has decades to go before they are able to show the same level of professionalism that the Americans do. They hire hundreds of people just to look smart for investors that come by. There are job openings over there for foreigners to drink coffee, read computer screens, and talk like a foreigner so that investors think they are real.

    My sister works in China. Whenever a worker over there makes a mistake that costs money, they don't do it like us. The worker is yelled at in front of his coworkers and humiliated to the rest of the company. That worker is then put back to work. He will not only not want to take the risk again, he will actively work against a second chance at it.

    That's what the Chinese are afraid of when it comes to us. Not only are we more creative than they are, but we don't give up. We just keep coming and coming until the problem is solved.

  • Report this Comment On February 10, 2012, at 1:41 AM, BBLBBD wrote:

    I may be a bit glib in my opinion, but there is still some serious questions that need to be answered. If the economy grows so much per year, why should the welfare spending increase as well...shouldn't it decrease ? Most government programs with automatic increases are things that should decrease with a growing economy. I did not go to USA government schools, so I don't know this way of thinking. Also, let's look at this round of globalization (this is one in a lot of rounds of globalization if you look at history). This one directly hits labor. Face it, the cost of labor will go down. Sorry laborers (of which I used to be one), but the wages will decrease. Demographically, that is political. If you are a leftist, you like that the there is no assimulation. We cannot discuss that.

  • Report this Comment On February 10, 2012, at 1:57 PM, DJDynamicNC wrote:

    @BBLBBD - your comment includes several assumptions that may be flawed. For example - assuming that a growing economy means that welfare spending should go down. Certainly that can be the case, and frequently has been in the past, but it's not necessarily the case, because a growing economy that is poorly distributed yields no gains for those at the lower levels.

    Second, you made a pretty big leap from "the cost of labour will go down as the labour pool is expanded" (which nobody is disputing) to "people on the left like that there is no assimilation." I'm not sure where you get that idea or how those two ideas interrelate. I'd be interested in your explanation for that reasoning, given that I am actually a leftist and actually in favour of assimilation, which would seem to contraindicate your theory.

  • Report this Comment On February 10, 2012, at 2:09 PM, hbofbyu wrote:

    When I look at China I see a huge work force. I also see unsustainable growth, rampant pollution, and a corrupt political structure with no respect for intellectual property or business law.

  • Report this Comment On February 12, 2012, at 8:33 PM, aleax wrote:

    @BBLBBD, you say "Most government programs with automatic increases are things that should decrease with a growing economy". The only major one I can think of with an *automatic* increase is Social Security, and the increase is tied to inflation -- which goes UP with a growing economy.

    Many important increases are not automatic but nearly so, for example SS's costs increase when people retire -- which is mostly tied to their getting old (a demographic reality which will continue no matter the state of the economy).

    Medicare, defense, national security, are all mostly driven by external factors (people getting older, voters wanting more military &c) and if anything the costs increase with a growing economy (specialized forms of inflation).

    If you have in mind e.g unemployment benefits, they ARE decreasing ($156B in 2010, $116B in 2011) - but a lot of that comes from the States (so doesn't affect Federal budgets) and the Fed part's so small (compared e.g to $662B for defense in 2012, and even that's slightly down from over $700B in 2011) that it makes little overall budget difference.

    Then you say "If you are a leftist, you like that the there is no assimulation. We cannot discuss that." -- maybe you can't discuss that, but the facts on the ground disagree with you.

    States passing strict anti-immigration laws like Alabama do so with very right-wing legislatures and governors, far from leftist ones; the leftists parts of the country, like e.g the City of San Francisco, on the contrary, adopt legally dubious "sanctuary" policies (local officials refuse to cooperate with enforcement of federal immigration law, thus undocumented residents mostly live there without fear of consequence).

    So, the political reality on the ground is exactly the opposite of your "cannot discuss" apothegm...

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