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Structural Nightmares for US & China—But of a Different Kind

One day, reality sets in. The most powerful force in the universe isn't love: It's the bond markets.

A Chinese and U.S. flag flutter in front of Tiananmen Gate on November 16, 2009 in Beijing of China.
ChinaFotoPress|Getty Images
A Chinese and U.S. flag flutter in front of Tiananmen Gate on November 16, 2009 in Beijing of China.

As Nouriel Roubini said this morning on Squawk Box, in a conversation with political scientist Ian Bremmer: "The bond vigilantes have not woken up for the US treasury market—yet."

Roubini's comments focused largely on the structural challenges of the United States. According to Roubini, here is the economic driver of the broader challenges the U.S. economy faces: "You can borrow at zero rates at the short end, and at 2.5 percent on the long end, why would you want to sacrifice when you can kick the can down the road?"

Democrats are dead set against entitlement reform—and the Republican Party is opposed to any kind of increase in taxes. And, Roubini believes, without major changes on both sides of that fiscal equation, it is nearly impossible to solve the United States' looming fiscal crisis.

In 2 to 3 years, Roubini says, there may be major insolvency issues with the individual U.S. states.

"It isn't just California," he says. The problems extend to an ever expanding constellation of U.S. states. And, in the event of major insolvencies within the states, the federal government may need to backstop all of those debts. And, in states like California , the size of that debt is staggering.

And then, once the federal government assumes the debts of the states, according to Roubini, you run into exactly the same issues we now see in Europe: Larger entities assuming the debt obligations of smaller entities—which, in effect, enlarges and concentrates the problem.

And then there is China.

According to political scientist Ian Bremmer, president of The Eurasia Group, China has considerable structural issues of its own to contend with.

The Chinese central bank recently raised their reserve requirement by 50 basis points, presumably on fears of escalating Chinese inflation.

In reference to the underlying inflationary pressure in the Chinese economy, Bremmer predicts "You're going to see price controls soon on food."

What's the reasoning behind that prediction?

To begin with, there has been a 62 percent increase in the price of foodstuffs announced by the Chinese in the last few days. Somehow most major economic observers didn't see that coming, according to Bremmer.

This could portend a Chinese future beset by escalating prices in general, and on food prices in particular. And that could require drastic interventions by the Chinese government.

(Commentators in some quarters have been sounding the alarm rather intensely lately on the increasing probability of a Chinese asset bubble—and predictions of inflation and overheating seem to arise in reference to China these days with increasing frequency.)

The price controls on food may become a political necessity for the Chinese, according to Bremmer. "They don't want to see any social unrest. It's an absolute red line for them," he said.

Roubini added—in a cheerful coda—that the policy direction China is heading in will lead to a predictable result: Rationing.

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