By Minxin Pei
To be sure, smart Chinese technocrats, particularly those in the People’s Bank of China (the Central Bank) have long been aware of the pitfalls of a rigid currency regime and excess forex reserves. They advocated a more flexible forex system and a gradual revaluation of the renminbi. But as we know, economic decisions of such magnitude are made by politicians, not technocrats. Beholden to powerful local interests (mainly coastal export-oriented businesses and their allies in the government), Chinese leaders have dithered on currency reform – and dug themselves deeper and deeper in the dollar hole.
One obvious question to ask here is whether Chinese leaders know the phenomenal risks of holding trillions of dollars in US debt, given the low interest rate and the depreciating value of the dollar. Should Beijing have diversified its forex investments? Why not invest in assets not denominated in the US dollar?
The answer is, sadly, China has tried practically every trick known to get into non-dollar assets. It has set up a $300 billion sovereign wealth fund to invest excess foreign reserves in foreign companies. It has encouraged state-owned companies to acquire assets abroad, such as natural resources and firms. It has launched an experimental scheme to settle foreign trade in the renminbi, instead of the dollar. It has dabbled in purchasing distressed European sovereign debt. The list goes on.
Unfortunately, these efforts to diversify forex holdings have yielded disappointing results. Chinese attempts to acquire natural resources have met with strong resistance in most parts of the world (except in Africa). China’s sovereign wealth fund’s investments overseas haven’t been successful either, mostly due to political opposition. Chinese state-owned firms seem to have done better. But the tens of billions of dollars they have spent on projects may not generate economic benefits. Expanding the use of the renminbi to settle trade reduces currency risks, but does little to restrain the growth of China’s dollar holdings – in the two years since China began this experiment, Chinese forex holdings grew more than 50 percent.
So for the moment, China finds itself in a $2 trillion hole it has dug for itself over the last decade. It watches the political paralysis in Washington and the resulting economic uncertainty in complete helplessness. Contrary to the fears harboured by many Americans that China would use its mammoth Treasury holdings as a financial weapon of mass destruction against the United States, China is being taken to the equivalent of the financial cleaners in the unfolding US debt ceiling drama.
It’s tempting to accuse the Americans, the Republicans in particular, of behaving recklessly. But for Beijing, the more meaningful thing to do is to figure out how to get out of its $2 trillion hole. Allowing a more rapid pace of revaluation of the renminbi is clearly one. But there’s another – possibly better – alternative. Why not give each Chinese citizen $1,000 in US Treasury bonds and let them decide what to do? Call it a special social harmony dividend. This could transfer the financial risks from the Chinese state to the Chinese people, while boosting the wealth and consumption of the average Chinese – in other words, killing two birds with one stone.
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Pete
According to Zero Hedge, countries outside of the U.S. dumped 74 billion dollars in U.S. Treasuries, most of it over the weekend:
“Over the weekend, we observed the perplexing sell off of $56 billion in US Treasurys courtesy of weekly disclosure in the Fed’s custodial account (source: H.4.1) and speculated if this may be due to an asset rotation, under duress or otherwise, out of bonds and into stocks, to prevent the collapse of the global ponzi (because when the BRICs tell the IMF to boost its bailout capacity you know it is global). We also proposed a far simpler theory: “the dreaded D-day in which foreign official and private investors finally start offloading their $2.7 trillion in Treasurys with impunity (although not with the element of surprise – China has made it abundantly clear it will sell its Treasury holdings, the only question is when), has finally arrived.” In hindsight the Occam’s Razor should have been applied. Little did we know 5 short days ago just how violent the reaction by China would be (both post and pre-facto) to the Senate decision to propose a law for all out trade warfare with China. Now we know – in the week ended October 12, a further $17.7 billion was “removed” from the Fed’s custodial Treasury account, meaning that someone, somewhere is very displeased with US paper, and, far more importantly, what it represents, and wants to make their displeasure heard loud and clear. (Source)
Undoubtedly, the Chinese and other countries have recently discovered that Italy and Greece, with smaller debt to income ratios than the United States, are less riskier and carry a higher rate of return. This is because, unlike the US, the Rothschild/Rockefeller bond rating agencies have trashed their country’s debt ratings, forcing them to pay a much higher interest rate than U.S. Treasuries. Hey, if you take the risk, you might as well earn the reward! http://www.moneyteachers.org/Foreigners+Dump+Treasuries.htm
Norm
Firstly, while China is the largest *foreign* holder of treasuries it is not the largest holder. The largest holder is currently the Fed.
As for being taken to the financial cleaners, …seriously??? Has the author noticed the performance of bonds during the period that China has accumulated these large holdings in treasuries?
At least the author acknowledges that this position, which he calls a problem, but is the kind of problem I’d love to have, is of China’s own making by sticking to a currency peg that ensured massive trade surpluses accumulated.
Mostly this article displays a misunderstanding of Americas deficit problem and of its monetary system.
Matthew K. Seibert
Well I think that this is a situation where China has learned that investing in an unstable economy has it’s economic consequences. And I have been tossing around a solution.
The American economy has been growing at a sluggish pace, and this is largely due to the wholesale destruction of it’s manufacturing industry. According to the Council on Foreign Relations Working Paper, “The Evolving Structure
of the American Economy and the Employment Challenge,” the United States needs to add exports and balance it’s trade deficit.
So I argue for exactly that. Let’s build a mutually beneficial relationship between China and the United States, where more American goods or services are purchased, thus balancing the trade deficit. I’m advocating for more Chinese investment in American infrastructure, American manufacturing and the American service industry.
A key opportunity for growth would be low interest or no interest micro-loans to small business entrepreneurs in the United States. Another opportunity would be getting involved in public private partnerships between Chinese businesses and American projects. We can also integrate supply chains between American manufacturing and Chinese manufacturing so that more work can be done on the American side of the business to business chain.
It’s a simple philosophy, “give a little to get a little.” If you put Americans back to work, that puts more money in the coffers of the government. And that’s more money to pay back the interest on bonds.
In fact, this situation has led me to a new formulation of foreign policy. It is no longer a zero sum game. But rather, one in which the victor builds mutually symbiotic relationships with all players. So I look forward to the future. Hopefully, it will be a more peaceful, and more fruitful time.
ozivan
@Matthew K.Seibert. You’re a man of peace !! Have questions for you though.
What has happened to civil aviation side of Boeing ? A decade ago, they were the undisputed top exporter of commercial airplanes, but now the Airbuses seem to be overtaking them. Must have caused the loss of thousands of jobs.
And then, why aren’t the Americans massively developing the medical appliances, specialised pharmaceuticals, etc types of industries that create much employment, yet can withstand high US labor costs? These are items that China (and the world) wants to import in the future to improve the lives of their people. They are so many areas of innovation that US excels, which will be good exports to China, if US can produce them in massive economies of scale, rather than be known only for producing the best killing machines.
Anyway, it’s good to read your peaceful comments, for they bring goodwill to the world. Thank you.
Matthew K. Seibert
The major drivers of the American economy are financiers. These financiers can gain more profits from money markets and risky investment practices than from investing in the American economy. In essence, our investment class no longer invests in the United States.
Now I don’t blame them, because our system is in a sense, broken. Our publicly traded corporations are only tied to seeking profit–seeking higher returns each quarter. This is a short-term mentality. It does not encourage re-investment in the existing system, and therefore, our manufacturing industry is left to become obsolete and expensive. A solution to this problem would be to re-tier the system so that innovation and investment are placed ahead of pure profit. And an ideal example of this system is the German economy.
However, the Asian markets can learn from this mistake. By putting long term strategies for growth and investment ahead of the profit motive, businesses end up becoming more successful in the long run. Thus, I appeal to the Asian markets to come into the United States, and rebuild our economy using the long-term strategies that the United States investor class has abandoned.
a_candian_observer
@Matthew K. Seibert: Respectfully, I agree with your thoughts, though I may add, that the model can only work if the 2 parties respect their signed agreements, IPs, etc…
The question is, will the chinese be up to the task on this mutual respect for other’s ideas. Perhaps later but judging by what has happened up to now, I doubt this model will be fruitful.
Matthew K. Seibert
I understand your point. I think the incentive is still on the horizon. That is why us, forward-thinking individuals have diagnosed the problem early. Because it will only be so long until the United States population can no longer afford goods produced in China. And we won’t be able to pay back the bonds. So in order to avoid that future, re-investment in symbiotic opportunities seems like a much better course of action.
Clove
It looks to me that treasuries are near yearly highs and a conservative estimate would put 95% of all US treasury assets that China owns in the money. If that’s taken to the cleaners, sign me up.
mareo2
“…Contrary to the fears harboured by many Americans that China would use its mammoth Treasury holdings as a financial weapon of mass destruction against the United States, China is being taken to the equivalent of the financial cleaners in the unfolding US debt ceiling drama…”
Quite a disturbing vision, because my country stand next to China in the size of big US debt owners.
John Chan
@mario2:
I thought Japanese support USA full heartedly, Japan has sacrificed a lot for the USA, USA robbed huge amount wealth from Japan thru the follow grant scams, 1985 plaza accord, forcing Japan to buy huge amount of US Treasury notes, and making Japanese government to borrow excessively from its people.
mareo2
Your understanding of what other asians think and do seems to be limited to stereotypes. Japan alliance with the US is a complex love and hate relationship but the final effect is similar to what the ROK and the ROC think and do. Unlike you I am able to make an autocritic and as far as I can see in my country we failed to develop an economy that rely less on how god or bad the economy of others countries is. But even if we developed a stronger domestic economy, the low birthrate index is killing that option for a healthy growth. Blame the mistakes we committed to other people is not going to save my country, my compatriots dont do it but they certainly are apathetic. I guess that the GoJ expended so much borrowed money in keep people well feed and in a relative luxury lifes that no one want to really think what is going to happen to us if the ecomonies of the US and/or China fall.
David
Yes, why not give every citizen $1000 and watch inflation soar.
Charles
This is a very peculiar article.
First, the US government guaranteed mortgage-backed securities against default, substantially improving the value of China’s holdings. Second, as interest rates have fallen, the value of securities with higher long rates has risen. Meanwhile, China has nearly maintained the dollar peg, so it has not suffered the full currency risk borne by other creditors. (In this, it has reduced the purchasing power of its citizens in favor of maintaining its manufacturing employment). Finally, the US has acted in the favor of its creditors to the grave disadvantage of its citizens by engaging in austerity.
The latter is, in fact, the only step that China has taken that is not entirely in China’s favor, since applying the screws to the American people weakens their long-term creditworthiness and hence the long-term value of the debt as well as the ability of America’s markets to absorb China’s goods.
The solution the author suggests–basically a very complicated tax rebate– would be very good for China’s financial industry, which would get paid for either selling the Treasuries or for managing the interest on them. And certainly the Chinese people deserve a raise for the hard work they have done in turning their country around. But… why not just raise wages? This could be done very easily by allowing the renminbi to float freely, lowering the relative costs of food, oil, and other commodities which are one of the heaviest burdens borne by working people.