BY MARK A. GROOMBRIDGE | DECIDE AMERICA
Wednesday, August 10, 2011
China, the world’s No. 2 economy, has sharply rebuked the United States for spending beyond its means and what state-run media outlets have called an “addiction to debt.” However, with the rest of the world economy struggling and until China reorients its economy away from exports, it is not feasible for China to unload its $1.1 trillion in U.S.-government debt.
Over the course of the past few days, China has issued stinging criticisms of the United States for its failure to bring down spending and resolve its structural debt problems. In demanding that the United States take action to protect Chinese assets, official media outlets run by the state, such as the Xinhua News Agency, lambasted the United States for its failure to get its economic house in order and holding the world’s economies “hostage.” The reaction to the debt ceiling deal was also cool, with Xinhua noting that the 11th hour deal “failed to defuse Washington’s debt bomb for good, only delaying an immediate detonation by making the fuse an inch longer.”
As is customary in China, the response by the senior leadership in Beijing was more restrained. Chinese Premier Wen Jiabao, in a statement issued by the State Council, commented on Tuesday that “China urges nations to coordinate and implement concrete and responsible fiscal and monetary policies to secure the safety of investments.”
Currently, China has $3.2 trillion in foreign exchange reserves, two-thirds of which are estimated to be invested in dollar assets around the world. According to official figures, China holds $1.16 trillion in U.S-government debt instruments. It is well-known, however, that China also buys U.S. Treasuries through intermediaries in places such as Hong Kong and London. When those estimates are included, some analysts conclude that China holds closer to $1.6 trillion, or roughly 17 percent of the federal debt in public hands.
Earlier in the week, Zhou Xiaochuan, the Governor of the People’s Bank of China (China’s central bank) remarked that China would “closely observe” the situation in the U.S. and that China would continue to diversify its foreign currency investments. While China has routinely issued statements on the need to diversify its holdings, it has taken few steps to do so.
The factors most often cited for China’s refusal to stop buying U.S. Treasury bills and other securities include the lack of suitable alternatives, and that a large-scale sell-off would jeopardize China’s economy, particularly its policy of export-led growth. China intentionally keeps the value of its own currency, the yuan, low against the dollar in order to artificially promote exports. A sudden and massive selling of U.S. debt holdings would mean that the dollar would weaken further and the yuan would appreciate. The consequence of such a sell-off would be a further erosion of China’s assets and more competition for Chinese exports, something it has not been willing to tolerate.
Despite the enjoyment the Chinese officials no doubt got from zinging Washington for its inability to cure its “addiction to debt,” they are stuck for a straightforward reason – there is nowhere else to go. Neither Europe nor Japan offer an attractive alternative, since both have their own share of economic problems, and neither offer asset markets deep or liquid enough. While down ten percentage points to 60 percent, compared to 70 percent a decade ago, the U.S. dollar is still the dominant foreign exchange reserve currency. Moreover, if China did attempt to diversify more into Europe or Japan through, for example, buying sufficiently large quantities of euros or yen, they would likely risk a protectionist backlash. Increasing the gap in value between the yuan and the euro and yen, respectively, would make Chinese exports against European and Japanese goods more competitive. Neither Europe nor Japan are as accommodating and willing as the United States is to run a long-term, artificially created trade deficit with China.
More broadly, though, China’s ‘addiction to U.S. debt’ is a direct consequence of their own domestic economic policies. For several decades now, China has encouraged exports and done little to encourage domestic consumption at home. They have essentially starved the middle-class of resources by having the People’s Bank of China borrow from the Chinese people and keep the value of the yuan low in order to subsidize exports. With massive amounts of state-led investment, they relied on world markets to absorb excess capacity. The result of this policy is that China has accumulated massive foreign exchange reserves to the tune of $3.2 trillion.
For years now, Chinese leaders have said they will take steps to increase domestic consumption at home and try to wean the country off what even they acknowledges is an over-dependence on exports. Beijing has been reluctant to do so, however, given its paranoia about social unrest. It is well-known that many of the state-led investment projects have been questionable, particularly in areas such as construction. Some economists estimate that roughly up to a quarter of all loans issued by Chinese banks in recent years could sour. The government is fearful that if it adopts much-needed market-oriented reforms too quickly, there will be massive unemployment and widespread protests, threatening the stability of the government.
The Chinese government knows its export-led growth policy is increasingly unsustainable and cannot continue indefinitely. A growing number of countries, most notably India and Brazil as of late, have made clear their impatience with the slow pace at which China has allowed the yuan to appreciate. They have so far, however, only taken minimal steps to reorient the economy away from exports. Many analysts, including this author, believe that the yuan is still undervalued by some 25 percent.
China may not like Washington’s economic policies, nor like its dependence on economic developments overseas more broadly, but they have no one to blame but themselves. Until China reorients its economy away from one based largely on exports, its criticism of U.S. economic policy will fall on deaf ears and its threats to diversify are largely empty. There simply is no place else for China to go.
Mark A. Groombridge has worked on a wide range of international security and trade issues for the U.S. Department of State, the U.S. Mission to the United Nations in New York, and the U.S. Commerce Department. He is Executive Director of Decide America, an organization dedicated to generating discussion on national security. Dr. Groombridge holds a Ph.D. in Political Science from Columbia University and a B.A. in Chinese and International Relations from the University of Minnesota.
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