Lessons from US debt farce
Stock markets surged, the US dollar gained and gold fell on relief at the news that President Barack Obama and leaders of the two major parties in both houses of Congress had agreed on a deal to raise the country's US$14.3 trillion debt ceiling just in time to avoid a default today.
Even before the deal's approval by Congress, a lively inquest has started into who is to blame and what will be the lasting damage of the row.
In reality, the shenanigans that pass as US politics have exposed yet again the danger of reliance on the US and the fragility and deficiencies of the global financial system. When it comes to collateral damage, the most vulnerable country - after the US itself - is probably Japan.
Officially, Beijing has refrained from comment on what has been going on in Washington. But Li Daokui, an adviser to the People's Bank of China (PBOC), warned back in June that the US was 'playing with fire' and urged Washington to ensure that China's vast holdings of US treasuries were safe. In the last week the Chinese media stepped up criticism.
Xinhua ran a signed editorial by Deng Yushan accusing US politicians of playing a 'dangerously irresponsible' and politicised 'game of chicken' that risks 'strangling the still fragile recovery of not only the United States but also the world as a whole'. It called on America to kick its 'debt addiction'. People's Daily kept up the pressure, warning that a US debt default could weaken the US dollar and launch a 'torrential flood' of liquidity on to the world economy and cause widespread inflation.
China has its supporters inside the US who have also been quick to complain about America's bad behaviour. Stephen Roach, a faculty member at Yale University and non-executive chairman of Morgan Stanley Asia, warned that China, as the biggest foreign buyer of US government paper, 'will soon say 'enough'. Then the big question is: in the absence of Chinese demand for Treasuries, how will the US fund itself without suffering a sharp drop in the dollar and/or a major rise in real long-term interest rates?' He said senior Chinese officials were 'appalled' by the way in which Washington was letting politics overwhelm financial stability.
Roach believes that China can achieve its threat to stop buying US Treasuries by raising the share of consumption in GDP, thus absorbing surplus savings and bringing the current account into balance or even a slight deficit by 2015. This may prove easier done in the paper plan than in real economic life, and, even if successful, it would still leave China and Japan each with a hoard of more than a trillion dollars of Treasuries vulnerable to falls in the value of the US dollar. Some economists think that Beijing protests too much in blaming only the US and has forgotten that US Treasuries were bought as part of a Faustian deal that allowed China to use exports as the main engine of its rapid economic growth.
Professor Michael Pettis of Peking University is the most eloquent of those who understand China's trade-off. 'The US has been arguing for years that China had to raise the value of the currency in order to rebalance the global economy and bring down China's current account surplus and, with it, the US deficit,' he writes in his blog. 'China responded that it could not do so without causing tremendous damage to its economy and that anyway the problem lay with the US propensity to consume. For that reason China continued to accumulate US dollar assets. As it bought US government bonds it was able to generate higher domestic employment by running large trade surpluses, with corresponding deficits in the US. Remember that net capital exports are simply the obverse of trade surpluses [or, more correctly, current account surpluses], and one requires the other. If China buys huge amounts of dollars, the US must run a deficit.'
Pettis adds that, whoever you think is right, it is not the obligation of the US to be thinking of maintaining the value of the PBOC's portfolio: it should be concerned about domestic inflation and the value of the dollar for its own economy.
That is the first reason to be worried about what has been happening in Washington. In one sense the whole stand-off has been unnecessary because Congress still has to approve budgets, spending and taxation each year. The debt ceiling has been raised 74 times since 1962, so it was hardly a big deal to lift it again.
The whole debate has gone on remorselessly and without any sense of humour or imagination as right-wing Republicans set the agenda with their refusal even to consider tax increases but determined to slash government spending that is a lifeline to millions of poor Americans.
With unemployment still at 9.2 per cent two years into a supposed economic recovery, former treasury secretary and White House adviser Larry Summers is right that the jobs deficit should be the number one priority. Get Americans working again and income and tax revenues will rise to trim the deficits.
Once again, the crisis and - the Chinese press is right - the kidnapping of American politics by irresponsible elements has exposed the threadbare nature of the global financial system. It is time for China to consider its international obligations and make the yuan more international, with all the awkward implications for domestic policymaking. And it is time, too, for the IMF to look again at a new reserve currency.