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
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.
