Okay, these goes back to the 80s. Trump explained to interviewers that when you owe a lot to someone or a bank, you own them. Let us say a smallish bank (which you picked on purpose for that reason) has assets of $200 million. Those assets include all of the outstanding loans. So you borrow $100,000 which is .05 percent of their total assets. You get in arrears and they put pressure on you to pay. You mention declaring bankruptcy and they laugh in your silly face. They can call out the lawyers on you and the revelation that .05 percent is in the air means nothing to the public or the stock holders. However, if you borrow $100 million dollars from that same bank and you threaten to go public with talk of bankruptcy....well half your assets are in danger of disappearing entirely or to be greatly reduced to say...10 cents on the dollar. That scares the crap out of the bank owners if it happens and it scares the crap out of the stock holders if it is possible. Regulators will be taking note. So, as a responsible bank owner you are going to tread much more lightly if you have a huge outstanding loan.
Same thing with China, yes, China could demand the money or sell the debt (which might be their best course of action) to other countries or banks. If the US floated the idea that the US may default on their debt to China only then the value of that debt if you want to sell it is greatly reduced. If China holds the debt then they could lose a large part of their economic might if the bottom falls out. Who's going to pay for those islands and that blue water navy? Of course, the US will be hurt by such an action but you could also collapse China's economy which is on uneasy footing already. Originally Posted by JD Barleycorn
I think the original quote came from John Maynard Keynes:
“If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has.”
While your example explains the concept correctly, it isn't very sophisticated or reflective of reality. First, no bank will loan out half its assets to a single borrower. Look up the term “legal lending limit”. It varies depending on type of bank, but regulators generally do not allow a bank to risk more than 15% of its CAPITAL (not assets) with a single customer. Second, even when a loan goes bad, the bank can usually recover a significant portion if it is secured by collateral and/or guarantees. In bankruptcy, secured creditors are paid first. Trump knows that since he is in real estate and several of his properties went bankrupt.
However, my main objection to Trump's analogy is it doesn't apply here. Yes, China is a creditor of the US Government, but it's not a bank. If China wants to “demand the money” and hold (non-interest-bearing) cash dollars instead of (interest-bearing) Treasury securities, it is free to do so although I don't know why it would. The Treasury bond market is huge and extremely liquid. The US Government does not have the option to say we may default on our debt to China. Everyone knows the Federal Reserve can furnish dollars on demand. And if it did the inconceivable and missed an interest or principal payment, this would roil the entire market and hurt ALL debtholders, not just China. China's international monetary reserves are large ($3.2 trillion) and diversified. Its economy would not “collapse” if the dollar portion of its reserves lost value. But our own economy would be at grave risk if investors ever concluded they cannot trust the “full faith and credit” of the US federal government.
