China Warns US on Debt Default as ‘Playing with Fire’

Here is another spectacle, China warns the US of ‘playing with fire’ by tinkering with the prospects of default.

From yahoo.com

Republican lawmakers are "playing with fire" by contemplating even a brief debt default as a means to force deeper government spending cuts, an adviser to China's central bank said on Wednesday.

The idea of a technical default -- essentially delaying interest payments for a few days -- has gained backing from a growing number of mainstream Republicans who see it as a price worth paying if it forces the White House to slash spending, Reuters reported on Tuesday.

But any form of default could destabilize the global economy and sour already tense relations with big U.S. creditors such as China, government officials and investors warn.

Li Daokui, an adviser to the People's Bank of China, said a default could undermine the U.S. dollar, and Beijing needed to dissuade Washington from pursuing this course of action.

"I think there is a risk that the U.S. debt default may happen," Li told reporters on the sidelines of a forum in Beijing. "The result will be very serious and I really hope that they would stop playing with fire."

China is the largest foreign creditor to the United States, holding more than $1 trillion in Treasury debt as of March, U.S. data shows, so its concerns carry considerable weight in Washington.

"I really worry about the risks of a U.S. debt default, which I think may lead to a decline in the dollar's value," Li said.

This just shows how governments have been addicted towards profligacy and inflationism as recourse to economic predicaments.

By advocating an increase of US debts, the US will genuinely be “playing with fire”.

Eventually this spending-deficit cycle will reach a point where the US economy won’t be able to pay her liabilities and will prompt her to an outright default or pursue hyperinflationary policies. So China is effectively asking the US to kick the can down the road.

However, these warnings do not just come from China, but also from the Fed’s James Bullard and one of the key credit rating agency, the Fitch Ratings

From the Reuters (hat tip Dr Antony Mueller)

A default would have severe reverberations in global markets, a top Federal Reserve official said just hours after Fitch Ratings warned it could slash credit ratings if the government misses bond payments.

St. Louis Federal Reserve Bank President James Bullard told Reuters on Wednesday "the U.S. fiscal situation, if not handled correctly, could turn into a global macro shock."

"The idea that the U.S. could threaten to default is a dangerous one," he said in an interview.

"The reverberations in those global markets would be very severe. That's where the real risk comes in," Bullard warned.

So the political pressure to raise debt limits has apparently been escalating.

Once the US Congress approves such actions, which I think they will, this gives the Fed another rational for QE 3.0: insurance against the risk of a bond auction failure as previously discussed here.

But while China warns of a default, the fact is that the US has already been partially defaulting on her debt via inflationism (QE 1.0 and 2.0)

Repeating what Murray Rothbard wrote,

Inflation, then, is an underhanded and terribly destructive way of indirectly repudiating the "public debt"; destructive because it ruins the currency unit, which individuals and businesses depend upon for calculating all their economic decisions.

So China prefers indirect default by inflation than an outright default.

Finally another paradox is that this warning of China comes amidst what appears to be her declining interest to finance the US.

True China owns lots of US debts (following charts from zero hedge)

But China has been buying less during the past months

Bottom line: Global policymakers appear to be averse at imposing fiscal discipline and would choose the inflationism route instead.

These actions manifest what I call path dependency or the bailout mentality via inflationism. Until the next crisis implodes such dogmatist approach simply won’t change.