The downgrade of U.S. government debt has put China, the United States’ largest creditor, in a tough spot.
Though Beijing has scolded the United States over “its addiction to debts,” Chinese officials are caught in a double bind — unable to dump their mountain of U.S. dollars and at the same time getting a tongue-lashing from their own citizens for being Uncle Sam’s hapless banker.
The Chinese government has built what is now the world’s second-largest economy in part by keeping its currency cheap in order to subsidize exports. To do that, it has bought gobs of U.S. Treasury bills and other securities. Any big move on China’s part to unload its $1.2-trillion-plus trove of American debt would only result in a self-inflicted wound: sinking the value of the dollar further and eroding the value of its own reserves.
For the moment, at least, the economic and political consequences of dumping dollars are likely to keep Beijing from taking any such drastic action.
“There really isn’t a better choice than U.S. Treasury bonds,” wrote Huang Yiping, professor of economics at Beijing’s Peking University, in a commentary published Monday in the influential financial magazine Caixin. “The basic requirements for foreign reserves are safety, stability in value and liquidity. Although U.S. Treasury bonds might not meet the first two criteria right now, the problem is still that we do not have a better choice.”
But if the United States and the global economy slide into another downturn — a prospect that has risen sharply in recent weeks — Chinese officials could be forced to change course.
The bind Chinese officials are caught in reflects both the country’s wildly successful economic strategy and its far more precarious political situation, in which officials see social stability as closely tied to continued economic expansion — so that more and more of its billion-plus population can share in the financial rewards.
If Standard & Poor’s downgrade of U.S. debt on Friday accentuated what everybody already knew about America’s fiscal woes, it also brought into sharp relief China’s mirror-image problem: an economy not consuming enough domestically and instead relying too heavily on exports to the U.S. and other developed nations.
“China’s [economic] success is a joint product of Chinese action and U.S. inaction,” said Peter Morici, a University of Maryland economist, referring to Beijing’s intervention to control its currency value and boost exports, and Washington’s reluctance to fight against it harder. As a result, he argued, “America’s fiscal woes are a product of both countries.”
Yet just as it’s getting harder for the U.S. to keep borrowing and spending beyond its means, it’s getting increasingly difficult for China to continue a policy of accumulating more dollars as a byproduct of suppressing the value of its currency, the yuan. Apart from the political heat, it’s costly for China’s central bank to buy billions in foreign currency, mainly dollars, to keep the yuan weak.
Despite pledges to rebalance the economy toward domestic consumption, China’s export sector and the fiscal policy that supports it remain entrenched.
By providing millions of jobs and cheap financing for the nation’s banks, China’s export manufacturing is considered a linchpin of social stability. The scheduled turnover of China’s top leadership next year only underscores the impulse not to rock the boat.
“China’s philosophy is to do things gradually because they don’t like dramatic change,” said Li Jie, head of the Reserves Research Institute at the Central University of Finance and Economics in Beijing. “We have a saying: ‘You don’t cry until you see the coffin.’ They don’t have an incentive to change the status quo.”
A new global recession could unsettle the status quo, however, weakening demand for Chinese exports and threatening the rapid growth that has contributed to stability.
Nagging inflation limits China’s ability to offset a slowdown by unleashing another round of stimulus. Economists say increasing the value of the yuan would address inflation by making imports cheaper and reduce the nation’s money supply. But that would require a sea change in Chinese policymaking.
Recognizing this conundrum, China has spent the last few years looking for alternative places to invest. What has it found?
Not a whole lot.
Beijing has bought gold, European and Japanese bonds and stakes in overseas companies, but the move to diversify has been tiny and remains piecemeal compared with the magnitude of available U.S. debt.
China’s 1,054 tons in gold reserves, for example, is worth less than 2% of the country’s $3.2 trillion in total foreign reserves – of which about 75% are estimated to be in dollar-denominated assets.
Nor is any other currency available to take on the dollar’s role. Neither the Japanese yen nor the Swiss franc, two other traditional safe-haven currencies, is as deep as the dollar. And Europe’s fiscal crisis dampens enthusiasm for its government debt.
The lack of options has rendered Beijing’s promises to diversify its holdings largely empty. Efforts to internationalize the yuan and diminish the role of the dollar are nascent at best.
Li, who advocates a free-floating yuan, said a major revaluation upward of the Chinese currency wouldn’t signal a crisis for exporters. He believes any loss to profit margins would be more than offset by cheaper costs for labor and raw materials. Yet that argument has little sway over others tied to China’s powerful manufacturing sector.
Despite the codependence with the U.S., state-run media have painted China as a maltreated lender, subject to the whims of a reckless Washington government that continues to drive down the value of the dollar to the detriment of its largest foreign creditor.
The messy fight in Washington — and the ensuing S&P downgrade — have likely emboldened China’s authoritarian rulers, and also provided fresh grist for ordinary Chinese to criticize what they see as America’s failed capitalistic model.
Over the weekend, China blamed “shortsighted political wrangling in Washington” for problems threatening to upend the global economy.
“It’s symbolic of a newfound confidence” that says “ ‘Look at where your system got you…We can do better than that,’ ” said Oded Shenkar, a China specialist at Ohio State University who’s been in Beijing this past week and has been following the discussion.
At the same time, the credit downgrading also has raised fresh questions and criticisms within China about the communist government’s fiscal stewardship.
Beijing’s dollar reserves are seen by many ordinary Chinese as a symbol of the nation’s toil over three decades of economic reforms. As one micro-blogger named Lin Junghua put it: “China’s reserves are the fortune accumulated through 30 years of hard work by the Chinese people.”
As such, an undercurrent of pessimism — and resentment — exists that those riches have been slowly squandered.
“Americans got cheap products, the Chinese government got U.S. dollars and Chinese people only got devalued [yuan] and worthless personal assets,” wrote another micro-blogger.
Pierson reported from Beijing and Lee from Washington