While rising inflation causes China and the rest of the world to remain concerned over its political, social, and economic stability, the US continues to fear its own growing mountain of debt and the risk of inflation. We turned to one of our fixed income experts and asked him to share his opinion on the link between the increased interest rates in China and the large deficit in the US. Here’s what he had to say:
Michael Romanovsky, a consultant on a wide range of business and organization-related matters in areas of economic analysis, business and marketing strategy, game design, and general project management, says that the effect of the recent Chinese interest rate change on US government debt is “three-fold.” All other significant factors staying constant, an interest rate hike curtails domestic spending in China, which can cause the trade deficit to increase. This subsequently increases US government deficit and debt “because of lower taxes generated from manufacturers.” Second, Romanovsky explains that an interest hike indicates that the US government will need to raise its own interest rate in order to attract buyers to the US federal bonds market, or “risk being unable to borrow significant funds.” The raise in interest rates greatly impacts any significant economic recovery in the US, because increased interest rates make it more difficult for business to borrow money to expand. Unfortunately, this leads to higher taxes and causes “the deficit to further decrease.”
Romanovsky adds that the changes and restructuring in the world economy, like the slow recovery of the US in the recent recession as well as the immense unemployment and changes of government in North African and Middle Eastern countries, greatly affects US debt. Contributing factors like “lower supply and higher demand of basic necessities” within unstable and vulnerable developing countries dampen economic growth throughout the world. Romanovsky references the projected increase in the cost of ocean shipping, which will have a substantial impact on US-China trade. In order for trade to become balanced and maintain economic stability, Romanovsky recommends a “re-alignment from high deficit spending to much lower deficit spending in the US” from both the private and public sector. Moreover, a re-evaluation of the yuan to decrease China’s trade deficit and manage increased Chinese consumption will cause the dollar to weaken, which means US debt will “effectively be lower” and US unemployment will be decreased due to “exportable product-based jobs.” However, this also means that US consumers will find many goods more expensive than before. Romanovsky recognizes that both countries have struggled to keep up with the shift in a relationship from “one of cheap goods in exchange for technology to one of all kinds of goods and services in exchange for all kinds of other goods and services.” Ultimately, the path to a more balanced trade between US and China is “riddled with potential price shocks” that the government must try, and prevent and individuals “must carefully monitor.”
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