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  • Dec 23, 2014
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CommentInsight & Opinion

China hears alarm bells over US debt

Stephen Roach says America's recent fiscal debacleis just one of many signals to China that it's timeto end an unhealthy codependency once neededto make up for their saving imbalances

PUBLISHED : Friday, 25 October, 2013, 5:47pm
UPDATED : Saturday, 26 October, 2013, 2:52am

Yes, the US dodged another bullet with a last-minute deal on the debt ceiling. But, with 90 days left to bridge the ideological and partisan divide before another crisis erupts, the fuse on America's debt bomb is getting shorter and shorter. As a dysfunctional US government peers into the abyss, China - America's largest foreign creditor - has much at stake.

It began so innocently. As recently as 2000, China owned only about US$60 billion in US Treasuries, or roughly 2 per cent of the outstanding US debt of US$3.3 trillion held by the public. But then both countries upped the ante on America's fiscal profligacy. US debt exploded to nearly US$12 trillion. And China's share of America's publicly held debt overhang increased more than five-fold, to nearly 11 per cent (US$1.3 trillion) by July this year. Along with roughly US$700 billion in Chinese holdings of US agency debt (Fannie Mae and Freddie Mac), China's total US$2 trillion exposure to US government and quasi-government securities is massive by any standard.

China's seemingly open-ended purchases of US government debt are at the heart of a web of codependency that binds the two economies. China does not buy Treasuries out of benevolence, or because it looks to America as a shining example of wealth and prosperity. It is certainly not attracted by the return and seemingly riskless security of US government paper - both of which are much in play in an era of zero interest rates and mounting concerns about default. Nor is sympathy at work; China does not buy Treasuries because it wants to temper the pain of America's fiscal brinkmanship.

Codependency was never a sustainable strategy. China just happens to have understood this first

China buys Treasuries because they suit its currency policy and the export-led growth that it has relied on over the past 33 years. As a surplus saver, China has run large current-account surpluses since 1994, accumulating a massive portfolio of foreign-exchange reserves that now stands at almost US$3.7 trillion.

China has recycled about 60 per cent of these reserves back into dollar-denominated US government securities, because it wants to limit any appreciation of the renminbi against the world's benchmark currency. If China bought fewer dollars, the renminbi's exchange rate - up 35 per cent against the dollar since mid-2005 - would strengthen more sharply than it already has, jeopardising competiveness and export-led growth.

This arrangement fits America's needs like a glove. Given its extraordinary shortfall of domestic saving, the US runs chronic current-account deficits and relies on foreign investors to fill the funding void. US politicians take this for granted as a special privilege bestowed by the dollar's position as the world's major reserve currency.

When queried about America's dependence on foreign lenders, they often smugly retort, "Where else would they go?" I have heard that line many times when I have testified before the US Congress.

Of course, America benefits from China's outward-facing growth model in many other ways, as well. China's purchases of Treasuries help hold down US interest rates - possibly by as much as one percentage point - which provides broad support to other asset markets, such as equities and real estate, whose valuation depends to some extent on Chinese-subsidised US interest rates.

And, of course, hard-pressed middle-class American consumers benefit hugely from low-cost Chinese imports - the Walmart effect - that enable them to stretch their budgets in an era of unrelenting pressure on jobs and real incomes.

For more than 20 years, this mutually beneficial codependency has served both countries well in compensating for their inherent saving imbalances while satisfying their growth agendas. But the past should not be viewed as a prologue. A seismic shift is at hand, and America's recent fiscal follies may well be the tipping point.

China has made a conscious decision to alter its growth strategy. Its 12th five-year plan, enacted in March 2011, lays out a broad framework for a more balanced growth model that relies increasingly on domestic private consumption. These plans are about to be put into action. The third plenum of the Central Committee of the 18th Chinese Communist Party congress, next month, will provide a major test of the new leadership's commitment to a detailed agenda of reforms and policies that will be required to achieve this shift.

The US debt-ceiling debacle has sent a clear message to China - and comes in conjunction with other warning signs. Post-crisis sluggishness in US aggregate demand - especially consumer demand - is likely to persist, denying Chinese exporters the support they need from their largest foreign market. US-led China bashing - a bipartisan blame game that reached new heights in the 2012 political cycle - remains a real threat. And now the safety and security of US debt are at risk. Economic alarms rarely ring so loudly. The time has come for China to respond with equal clarity.

Rebalancing is China's only option. Several internal factors - excess resource consumption, environmental degradation and mounting income inequalities - are calling the old model into question, while a broad constellation of US-centric external forces also attests to the urgent need for realignment.

With rebalancing will come a decline in China's surplus saving, much slower accumulation of foreign-exchange reserves, and a concomitant reduction in its seemingly voracious demand for dollar- denominated assets. Curtailing purchases of US Treasuries is a perfectly logical outgrowth of this process. Long dependent on China to finesse its fiscal problems, America may now have to pay a much steeper price to secure external capital.

Recently, Chinese commentators have provocatively referred to the inevitability of a "de-Americanised world". For China, this is not a power race. It should be seen as more of a conscious strategy to do what is right for China as it confronts its own daunting growth and development imperatives in the coming years.

The US will find it equally urgent to come to grips with a very different China. Codependency was never a sustainable strategy for either side. China just happens to have understood this first. The days of its open-ended buying of Treasuries will soon come to an end.

Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of the forthcoming book Unbalanced: The Codependency of America and China. Copyright: Project Syndicate


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Fair observation
J Rogers, a Yale alumnus
has expressed similar idea more broadly in "Street Smart"
Yale is Yale that has no or less what we have here
those whymak calls "drooling" phd's and "professors"
and their rubbish such as what appeared here last week
that stale prejudice of S Pepper
One U.S. Dollar once bought over Japanese 400 Yen. Now, it buys less than 100 Yen, plus Japanese labor is no longer cheap, even with the Bank of Japan buying Dollars to depress the value of the Yen.
The same cycle is happening in China, but would have happened much more slowly, had industry been able to move inland faster to cheaper labor markets. It can't, because various governments in coastal provinces own so large a share of manufacturing enterprises, rather than just renting them land.
Shanghai officials, for example, would sooner jump from atop tall buildings than let those captive plants migrate inland, which would happen due to cost pressures if they were privately owned. The official's alternative is to allow enough immigration to keep down wages. This explains why they allowed the city to grow from 10 million people in 2000 to 23 million in 2010. This has to halt at some point. 50 million?
Had the cadres not manipulated of currency and commenced all other manner of mercantilist policies, they wouldn't now be riding nearly so large a tiger and be in for so rough a ride.

The article 'Hong Kong ideal to host infrastructure bank, says JP Morgan chief' (10 October, 2013)was published by the morning post. Unfortunately, not enough attention has been paid to it.
Instead of buying US governent debt, Beijing can use some of its US dollar reserves to fund the infrastructure bank, which provides loans to Asian countries and companies. Gradually this will develop Hongkong into the centre of Asiandollars, resembling Britain's Eurodollar market. If successful, Hong Kong is able to truly rival New York and London as the world's financial centre. Shanghai will be left far behind.
One way is to make US$ loan to Thailand to enable her to buy China's high-speed trains. Thailand should be allowed to repay part of her loan in rice.
As a future loan centre, Hong Kong should settle its current dispute with the Philippines as quickly as possible. Afterall, more borrowers means more buisness.
If Beijing wants to develop Shanghai into China's NewYork, Hongkong should strive to become China's London. (Arguably, London has now surpassed New York as the global financial centre).
Chimerica should not last. This time is really different.
You sound delusional. Trade will once again determine financials, not the other way around. I learned the words "bright" and "pellucid" in Chinese today.


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