China Finds Vindication in U.S. Debt Crisis

The drama over raising the U.S. debt ceiling has been closely observed and also strongly criticized in China. From CBS News:

Chinese websites have been flooded with comments criticizing Washington for seemingly ignoring the interests of its single largest investor, China, and thus putting more than $1.2 trillion dollars in Chinese debt holdings at risk.

Not surprisingly, the idea that their government is investing Chinese money in assets that are losing value creates a great deal of concern for a lot of Chinese, and a great deal of anger, explains Peking University finance professor Michael Pettis.

Chinese officials are trying to get some political mileage out of the U.S. debt debacle. They’ve publicly criticized Washington’s growing financial problems, though few believe the Chinese government was ever truly worried its U.S. debt holdings would go belly-up.

China’s state-controlled media is also highlighting the supposed dangers of the U.S. democratic system – painting a picture that shows the high-stakes political infighting in Washington holding the global economy hostage.

Last week China’s Xinhua news agency published an editorial charging that the U.S. government is being “dangerously irresponsible” in how it is handling the debt ceiling issue. From CNN:

The Chinese government, the top international investor in U.S. Treasuries, had previously warned the U.S. government to get its debt under control or its credibility will suffer.

But state-run media outlet Xinhua has stepped up that criticism, saying the debate over raising the debt ceiling has “kidnapped” the worldwide economy.

“Such political brinkmanship in Washington is dangerously irresponsible,” Xinhua wrote in a commentary published on Thursday.

“The ugliest part of the saga is that the well-being of many other countries is also in the impact zone when the donkey and the elephant fight,” Xinhua said, referring to the symbols for the U.S. political parties. “The potential collateral damage is way too heavy.”

However, experts say that despite the rhetoric, China is unlikely to dump U.S. bonds even in the event of U.S. bonds being downgraded because doing so would also hurt China’s interests. From the New York Times:

It is the ultimate “too big to fail” global relationship, said Andy Rothman, an analyst in Shanghai for the investment bank CLSA.

If Beijing even hinted that it might try to sell part of its American debt, “other countries might sell their dollar assets,” Mr. Rothman said, noting that this would drive down the value of China’s holdings. “It would be financial suicide for China.”

China got into this situation, experts say, by indulging its own economic interests. To bolster what has become the world’s largest export economy, China has focused on policies that encourage domestic savings and hold down the value of its currency. The result: huge trade and current-account surpluses. China has accumulated more than $3 trillion in foreign currency reserves, far more than any other nation.

Most of those reserves are held in dollars, and recycled back to the United States through investments in Treasury bonds and other dollar-denominated securities — even stocks. And while some of China’s foreign exchange reserves are plowed into European and Japanese debt, those bond markets are not big or liquid enough to absorb the bulk of China’s ever-larger foreign holdings.

But even now, despite Beijing’s scolding about the debt impasse in Washington, China’s options may be limited.

”There’s really nothing different they can do,” said Eswar S. Prasad, a Cornell economics professor and former head of the China division at the International Monetary Fund. “Even if China felt the United States was going off a cliff, there’s no other place for them to put their money.”

August 1, 2011 10:32 AM
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