By Minxin Pei
The US debt negotiation ceilings are going to the wire. China, the biggest holder of Treasury debt, is watching on helplessly as it gets taken to the financial cleaners.
The political drama in Washington over raising the United States’ federal debt ceiling has grabbed the world’s attention. While the main protagonists in the play are the Republicans and Democrats, one spectator anxiously awaiting the outcome of the bitter partisan struggle is undoubtedly China, the largest single holder of US Treasury debt (roughly $1.1 trillion). In a nightmarish scenario of an American debt default, the prices of the Treasury bonds China has accumulated are bound to decline significantly. Even if the US government decides to pay the interest on outstanding bonds before honouring its other obligations, the financial markets will likely demand higher interest rates (especially if the US credit rating is downgraded), thus causing the prices of US bonds to fall. Because about 60 percent of China’s $3.2 trillion in foreign exchange reserves consists of dollar-denominated assets (in addition to $1.1 trillion Treasury bonds, China has bought hundreds of billions of dollars in mortgage-backed securities), the paper losses from the price declines of dollar-denominated bonds, and the depreciation of the dollar itself, will likely be in at least the tens of billions of dollars.
To Beijing’s credit, the Chinese government has kept relative silence so far. Except for vague calls for the United States to protect its investors, no Chinese officials have said anything that could be construed as a threat of dumping US Treasury debt if Congress fails to raise the debt ceiling. The official press, including tabloids known for nationalist rhetoric (such as the Global Times), has been restrained in its coverage on the issue. To be sure, China has maintained an ultra-low profile out of self-interest. It will only hurt itself more if it raises alarm about a possible US default and spooks the financial markets.
China’s $2 trillion dilemma is well-known. Since 1994, China has kept its currency, the renminbi, effectively pegged to the dollar. While initially this policy worked well in stimulating Chinese exports and stabilizing domestic prices, Beijing allowed the peg to continue for too long, mainly to maintain an undervalued currency in gaining a competitive advantage in foreign trade. By the middle of the last decade, the undervaluation of the renminbi became a hot bilateral issue between the United States and China as America’s bilateral trade deficits with China soared.
Under pressure from Washington, Beijing reluctantly began to raise the value of its currency in mid-2006 (when its total foreign exchange reserves totalled just under $1 trillion). China’s revaluation process was disrupted by the global economic crisis in 2008. Fearful that its growth could falter if revaluation made Chinese exports less competitive, the Chinese government suspended raising the value of the renminbi in late 2008. As a result, Chinese current account surpluses continued to balloon. The numbers are astounding. In July 2009, China reported $2.2 trillion in forex reserves, more than double the amount in 2006. Today, two years later, China’s forex reserves have reached $3.2 trillion.
Photo Credit: Flickr / SqueakyMarmot
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John Hobsoner
How is china getting taken to the financial cleaners? Since this debate began treasuries have skyrocketed in value. Usually when an asset you hold goes up in value, you make money. But thats only in the real world, and not whatever world this article was written in.
John Chan
Actually the author did not have bold enough view to analysis the “China’s $2 Trillion Holes.” If I were Chinese leader, I would look at the whole situation differently. As long as China can create jobs, improve living standards of its people and export all those products, the excessive forex reserve is a bonus. Export is important, without export, the excessive products will cause untold amount damage to China internally.
That excessive forex reserve is just the additional tool for China to extend its inference aboard and acquiring additional resources. Since China cannot use all of it forex reserve, contraction of the dead portion of the forex reserve although looks bad but actually does not do real harm. But if one views the situation in long-term perspective, the current turmoil in the US may be only a dip in a steady uptrend. All smart long-term investors know that they must sit tight thru the dip in order to rip the large gain in the end.
Of course all those big shot bankers, financiers, academics, writers, etc. have to do something to make them look worthwhile the excessive pay they are getting but not deserve at all.
Giving free money to Chinese is a good idea, as long as the free money is spent outside of China only, but this free money is difficult to benefit the poor in China.
Evaluation of RMB is nothing by nonsense, but unfortunately the author has to raise it in order to make him look liberal. I believe China tries to pop up USA and EU with that excessive forex reserve, but the USA and EU are not doing their parts of the work diligently.
ozivan
It’s a hard decision for US Congress to cut down on massive deficit spending, and what the US is doing now is the right thing, however unpalatable. It cannot go on like this forever. Don’t underestimate the US, as she has always the resilience and ingenuity to overcome hurdles, sooner or later.
The Americans cannot afford to lose on their financial credibility, the whole world, Germans, Japanese, Chinese, Taiwanese, etc etc will stand to lose together.
Should the unimaginable ever come true, with the collapse of the US Dollar, it will then give an opportunity for the Yuan to become the second world currency.
Friends, Trust the Americans, they will come through.
Leonard R.
China has gotten plenty of value for that money. It has has waged economic warfare against the US and gotten away with it. It has drained America of manufacturing jobs and kept the US Dollar artificially high on world markets. But those days are coming to an end.
If China won’t buy T-bills, that’s good. If it continues to buy them (and it will), the United States should take that Chinese money & invest it directly in new weapons systems to be used against the PRC, when the war we are already engaged in turns hot. And that will happen sooner than most people think.
The gravy train has pulled in at the station. And the PRC is going to pay dearly in the future, no matter what choice it makes. Whether it buys T-Bills or not, it’s a lose-lose for it going forward.
Sinodefender
Where is this Sino-American war you speak of? What is the point of just investing in military, if your economy is going to stall and people are going to complain… Show me how this is a lose-lose situation, if it buys more T-bills then it can strangle America, if it stops buying T-bills then if American dollar devalues it could save more money.
ozivan
@ Leonard R. the United States should take that Chinese money & invest it directly in new weapons systems to be used against the PRC,
Not a good proposition.
This thinking is exactly the reason why the US lost jobs to China. Weapons industry is a very high tech business, and highly skilled workers are required which numbers only in the thousands. The US needs to invest in non-weapons manufacturing eg pharmaceutical, medical appliances, revive its civil aviation like Boeing which is losing much ground to Airbus, etc etc that create jobs by the millions.
US is suffering from a malaise, of a very high tech military industrial complex on one extreme end and financial service industry at the other end. The middle section which is consumers manufacturing has hollowed out over the last 4 decades, firstly to the Japanese, then the Koreans, and now the Chinese.
It is wise, sound long term economic planning that matters, so the US shouldn’t blame it on the Chinese for their ills.If you’re an American, then you’re asking the US to dig deeper into a hole.
Asian Observer
China only owns 10% of total American Treasuries issued. If Treasuries tank, America pension funds and its allies will lose 9 times as much as China. America will sink like a stone. China will be severely affected in the short term but will survive and prosper to even greater heights without American hegemony hampering it.
America shows a lack of financial discipline. Mental nuts like Leonard R. are proposing higher interest rates for American housing loans and businesses.
America is a militaristic nation and dangerous as it abounds with irrational nuts like the above mentioned. The free world must act to contain and restrict this rogue nation in the meantime until it amends its pax american dream of being the sole authority in the world.
megakids
@Leonard R.
I really feel sorry for you. Whenever you comment you take such an anti-China attitude. This is a financial article and wherever you came from, you want to steer it into military conflict. What’s wrong with you and your life? Why are you so poisoned and vindictive?
J.R.
If you owe 1000 bucks from your bank, then the bsnk got you on your balls..
but if you owe more than 1 billion to your bank, then you got your banks at their balls ^^
ozivan
Haha…that’s true
Neil
Well Mr. Frank – Your expert comments pls ..
Frank
Why are you East Indians so interested in China?
a_canadian_observer
@Frank: Why are you so into insulting East Indians? Neil was just asking for your opinion.
Sam
Indians are interested in West Chinese because family planning officials steal babies in Hunan and sell them to make a buck.
Maybe Frank comes from Hunan and knows a few of them!
May be he makes some money that way too.
Besides insulting Indians surely he has something else he does in his spare time!
Maybe he can help them design some cars like the Geely that are not coffins on wheels, too!
lance sjogren
I would think China would be pleased that there are now some in Congress fighting hard for the US to cut down its massive deficit spending, which, if continued unabated, will eventually render the US dollar worthless, in which case China’s US Treasury Bonds will likewise be worthless.
There will be no short term debt default, the consequences would be too disastrous and enough of the members of Congress are aware of that to see to it that a default does not happen.