What can China do for the US’s debt?

What can China do for the US’s debt?

The Senate on Tuesday overwhelmingly approved a plan to raise the federal debt limit and cut government spending, ending a bitter partisan stalemate that had threatened to plunge the nation into default and destabilize the world economy. One day after a climactic vote in the House, the Senate easily approved the measure, 74 to 26, with significant majorities of both parties supporting it. Obama promptly signed the bill and submitted a formal request to Congress to lift the 14.3 trillion dollars debt ceiling, instantly giving Treasury 400 billion dollars in additional borrowing power.[i]

Foreign investors and economic analysts see further action as crucial to restoring the United States’ financial reputation. On Tuesday, critics in China and elsewhere warned that the initial debt-reduction package, which would cut about 1 trillion dollars from several government agencies’ budgets over the next decade, is too modest. And the United States should be complained that the last-minute agreement will not tackle the dangers that national health and retirement programs pose to the government’s long-term fiscal health.

The whole procedure of the so-called federal debt limit issue shows conflicts between White House and the Congress or between the two Parties. The fears China has about the deal which will neither energize the foundering economy nor require substantive changes to address America’s long-term fiscal problems, nor promote the determination of diversifying the foreign exchange reserve and more reasonable investment.

Yu Yongding, at Institute of World Economics and Politics in Chinese Academy of Social Science and the advisor of the Central Bank of China, said “U. S. bonds are not safe, but people think they are safe”. “That is a mirage.”  Yu repeated his call for China to reduce its Treasury holdings amid impasse among policy makers on raiding the U.S. government’s debt limit.

In March, Yu said that China, the biggest foreign holder of Treasuries with 1.16 trillion dollars of the securities, should halt purchases because of the risk of an eventual default. In June, he predicted that credit agencies would limit the severity of any downgrading of U. S. rating to avoid investor panic.[ii] Yu had already given advises for China to prepare the international financial crisis in 2008-2009. He called for the RMB internationalization which is based upon the reformation of domestic financial market and the regional cooperation in the East Asia.

The Administration of Foreign Exchange, facing domestic pressures from its unwise investment in US’s bond, said the foreign exchange reserve was not the hard-earned money by the ordinary people in China, while trying to avoid the responsibility from the misuse of investment in the United States’ debt bonds. Even if still China’s main foreign reserves are the dollars, there are very few alternatives for China to go somewhere else. The risks seemed to have not been previewed comprehensively.

The huge loss, caused by the manufactured default in US economy, should have given a serious lesson for China to remember the hidden risks in the US. Japan, who was also badly hurt by the huge amount of US Treasuries as its main foreign reserve and its massive investment in US’s securities in the 20th century after its economic prosperity in 1960s, completely collapsed since the Plaza Accord was signed in New York.

The Plaza Accord was an agreement between the government of Japan, France, West Germany, and the United States, and the United Kingdom, to depreciate the U. S. dollar in relation to the Japanese yen and German Deutsche Mark by intervening in currency markets. The five governments signed the accord on September 22, 1985. The justification for the dollar devaluation was twofold: to reduce the U. S. current account deficit, and to help the U. S. economy to emerge from a serious recession that began in the early 1980s. The agreement was successful in reducing the U. S. trade deficit with Japan, however, since then, the yen had significantly increased in value which ended-up in a serious recession, the so-called Lost Decade.

China, an averse of Japan, seems to have repeated the exact same mistake the latter had made. Both of them had to bear the cost for the United States’ extremely greedy consumption habits. That was wrong for Japan and is unfair for China. The coincidence of two countries’ mistakes and failures in that regard should have given them enough lessons. Will China face the destiny of the lost decades as Japan had been through?

Sincere cooperation between two nations, together with South Korea who is also much in the same shoes, might be badly needed for them to jointly overcome further impending economic disasters from US side due to their inescapably interlocked financial schemes for over a half century. Creating something like a Northeast Asian Regional Monetary regime for the trilateral financial security and continued economic developments might be an alternative direction they all should seriously contemplate.

[i] Lori Montgomery, “President Obama Signs Debt-limit Bill into Law”. Washington Post, http://www.washingtonpost.com/business/economy/the-debt-limit-obama-lawmakers-continue-to-discuss/2011/07/06/gIQAVwZX1H_gallery.html

[ii] Anoop Agrawal, “China’s Yu Yongding Says Safety of U.S. Treasuries Is a “Mirage””. Washington Post, http://www.washingtonpost.com/business/chinas-yu-yongding-says-safety-of-us-treasuries-is-a-mirage/2011/07/27/gIQAZ0rgcI_story.html

The author Yang Jingmin is an editor of M4.cn and can be reached at jingmin_yang@yahoo.cn

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