Fear Mongering on China Debt

Jeff  Carter
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Posted: Mar 03, 2012 12:01 AM

When you dip a bucket in the ocean and pull out some water, is there a dent in the ocean where you pulled the water out?

Of course not. Water runs in and immediately fills the gap.

Too many people think that marketplaces are like bathtubs. They think in terms of fixed pies. Market places are not like bathtubs. They aren’t fixed unless something sets up constraints to fix them. That something could be a government regulation, but it could also be market forces from another marketplace interacting as well.

Listening to the debate about things like the Volcker Rule, and fear mongering over China owning US debt really start to stick in my craw after awhile. Most of the people commenting have zero experience with an actual marketplace, and they are just trying to score political points by scaring people.

Markets are living breathing things. Each marketplace has its own heartbeat, it’s own rhythm. As a guy who traded in several markets I noticed that immediately. Eurodollars ($GE_F) didn’t trade like S&P’s ($ES_F). The crowd that was in the pit, and culture of the pit was different as well. And no pun intended, but trading hogs ($HE_F) was different than Eurodollars and S&P’s, but it was a different animal than cattle ($LE_F) too. If you ask a trader from the NYMEX, I am sure they will tell you Crude ($CL_F) was not the same as Natural Gas($NG_F) and at the CBOT, none of the grains($ZC_F, $ZS_F, $ZW_F) were alike. I hope you get my point.

Marketplaces have thousands of individual entities interacting within them. Each person trying to maximize their gain. Even when trading them on a computer, each has a slightly different beat. Although the computer has commoditized a lot of the differentiated culture.

When a big player abandons a marketplace, the market doesn’t die. Marketplaces exist for a reason. It is highly difficult to create a market where none exists unless there is true value for being there. Governments, and exchanges, can subsidize marketplaces for awhile. But, after the subsidy disappears most of the time the market will disappear unless real value is created.

An example of this is the carbon market places that European governments tried to set up, and the Climate Exchange in the US. If you hadn’t noticed, ($ICE) wrote off their entire purchase of the US Climate Exchange because as it turned out, there wasn’t a viable, living breathing marketplace inside it. The carbon market was artificial based on government regulations.

What will happen to the price of US debt if China exits the market? I doubt debt prices would spike seriously. Number one, it’s not realistic to think that China will exit the market because as long as they engage in trade with the US, they can’t pull out. They need to repatriate their US dollars in the most efficient risk free way possible and the only way to do that is buy US Treasuries. They can diversify away from the dollar in the foreign exchange market, but as long as the US GDP remains much higher than the Chinese GDP, the US will be the go to place for China.

As long as the structure of the marketplace is set up so it’s on a level playing field and competitive with very transparent price dissemination, the market will continue to exist and create value. If those characteristics are absent, people exit and the market structure breaks down.

The point is, there are plenty of players in the marketplace that will fill the gap that any large trader leaves when they exit. Just like the bucket of water in the ocean.

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