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Subject: Re: Price protest! by Unitech Students


Author:
peles economist
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Date Posted: Thu, Oct 16 2008, 12:05:16pm
In reply to: larsen 's message, "Re: Price protest! by Unitech Students" on Wed, Oct 15 2008, 04:30:18pm

Bro larsen, you are right, that China has recently stepped into the lime-light, financing US budget deficits. Traditionally Japan used to finance US budget deficits.

A layman might asked how this process works. Lemme explain that in here. When US government runs into budget deficits, it can either print money, or sell US treasury bonds to finance its budget deficits. Most often the US government issues treasury bonds to raise money to finance the deficit. When the trasury bond is in the market, anybody from the world can buy the bond either through primary or secondary markets.

Since Japanese government previously were running current account surpluses and the per capita income of Japanes was high, domestic savings was also high, consequently led to high investment offshore, mostly US treasury bonds. I believe thats whats happening with China now, given high economic growth and high per capita income. The Chinese people are currenly financing the huge budget deficits.

Just yesterday, i heard that the budget deficit for US government was a record high at 3-percent of GDP or around 600 billion US dollars. This has to be financed by other countries who are doing well, and i guess China and South American countries who are doing well so much would finance this deficit.

As for the bail-out, and the subsequent effect of that on the government coffers can have rippling effects on the world economy and i wont be surprised, if rates started to tumple as investment fund chase after low-risk financial assets.

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Author:
larsen
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Date Posted: Thu, Oct 16 2008, 02:50:10pm

Peles-economist,

(1)I concur with your concise understanding of movement of financial capitals as investment across international borders given the economic performances of the economies. China has used its current account surplus to invest in US investment banks and in US treausry bills.

(2)The investment banks have created financial derivatives such as credit account facilities to retail these funds to the household sector. It is evident that the US Federal bank has been very relaxed on such regulatory/monitoring roles over such activities of the banks in the past decades.

(3)Given huge investment in treasury bills, the interest rates have been much lower and thus note that the world interest rate being about 3% on long term government securities.

(4)Given point (2) and(3) the investment banks find that investment in real estate industry being much lucrative but pose higher risk. Thus, the investment banks invest also in the real estate industry.

(5)Due to financial problems, a houseowner in the US sells his/her house. Remember that this house houseowner has big credit account balance and also has borrowed from investment banks to buy the house as per point (4) and thus paying mortgage.

(6)When networth of selling the house (after loans and credit account balances) is very small to the houseowner. I note that most of the houseowners in US have noted that the networth of houseownership has been very small and some have even negative networth.

(7)In aggregate, due to drop in prices of houses because of the networth situation to sell a house, many houses have gone on foreclosure in the US.

(8)Remember that the investment banks are the providers of credit account derivatives and home/house loans and to lose investment due to drop in house prices triggered by the networth problem of house owners is a huge probelem for the investment banks. The investment banks have have used offshore investment funds from countries like China.

(9)This problem in point (8) has led to investment banks in US declareing financial problems which has spread through the world.

(10) The are other issues which have contributed to this financial crisis and I hope that the main problem lays in what I have just tried to describe.

I feel to understand the macro analysis of this issues with some confidence but some people would know a bit better by looking at the international flow of investment funds, investment portfolios such as treasury bills and investments banks engagement and operations, the central bank controls, the interest rates of financial investment portfolios, and the real estate industry relations with the banks.

Thank you for the discussion

larsen

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