The Chinese and US economies are highly interdependent

THE Chinese government is worried about the safety of its nearly $1trillion credit to the US government. In what is described in the US media as an ‘unusually blunt’ bit of ‘scolding’, last week, the Chinese Prime Minister Wen Jiabao criticised America’s “unsustainable model of development characterised by prolonged low savings and high consumption.” “We have lent a huge amount of money to the US. Of course, we are concerned about the safety of our assets,” said Mr Wen, and called on the US government to “maintain its good credit, to honour its promises and to guarantee the safety of China’s assets.” 

    Wait, watch, worry, and occasionally, scold the US government for its profligacy and gross mismanagement of the global financial system. Is there anything else the Chinese government could do to ensure the safety of its humungous share of the US debt and take a leadership role in stopping the global economy from plunging further into recession? 

    For a start, it could stop stashing on US treasury bonds. It could use the nation’s approximately $2 trillion foreign reserves to import goods and services to increase the consumption and welfare of its 1.2 billion people. These reserves belong to the people of the People’s Republic of China. Let them enjoy the fruits of their hard work and savings. Don’t waste these reserves in providing unlimited subsidised credit to US consumers. 

    Next, China could provide generous welfare programmes to put money into the pockets of the millions of Chinese workers who have lost jobs in the economic slowdown. The remaining funds, if there is still anything left, could be invested in foreign countries. Along with the $585 billion stimulus initiative, which is primarily expected to be invested in infrastructure, a boost to domestic Chinese consumption would compensate for the slump in exports to the US that will most likely worsen as the year 2009 progresses. 

    China’s government will perhaps not pay much attention to these suggestions. Worried and wary it may be about the state of the US economy and growingly reckless spendthrift habits of the US government, but China’s appetite for the US treasury bonds is insatiable. Throughout last year, even as signs of deterioration in the US economy were obvious, China continued to purchase US treasury bonds, in larger numbers than ever before. Since 2007, Chinese ownership of the US debt has doubled. As of December 2008, China owned $700 billion in US treasury bills. Its ownership of US debt is believed to be close to $1 trillion as China has also purchased US debt through third countries. 

    Last week, when Washington responded to the Chinese premiere’s remark on his worries about US debt with the statement —‘there is no safer investment in the world than in the United States,’ the Obama administration official was merely describing the behaviour of international investors, especially of the Chinese government. It is totally bizarre. The US economy is in the deepest recession in 70 years, its government is piling on an incredible amount of deficit, and most experts think that these deficits would not be enough to rescue the economy from recession. And international investors think that investing in the US is the safest in the world! 

    CONTINUED acquisition of US debt has put China in a precarious bind. If it begins to sell the US debt in any sizable quantity, the treasury market will collapse lowering the value of the Chinese credit to the US. If China keeps on accumulating US debt, the risk to the safety of its reserves will be enormous. The Chinese economy will become linked to vagaries of the US economy even more than ever. While it is unlikely that the US government will ever default on its debt — it can print as many dollars as it wants — the value of Chinese credit to the US government will decline in the event of a sharp increase in US interest rate or a decline in the value of the dollar. 

    The Chinese and US economies are highly interdependent. Their interdependence is unhealthy for the global financial system. China is America’s biggest creditor and trading partner. Americans buy the goods that Chinese factories produce, and China lends them the money to do so. For years, the US economy has been running massive trade and current account deficits, appropriating the savings of the rest of the world to satisfy its voracious appetite. But the rest of the world, including China and Japan also happily obliged by investing in the US treasuries. China, India, Japan and other Asian countries need to stop buying US treasuries, and invest in their own or in other Asian economies. 

    As foreign governments buy US treasury bonds, the dollar gets strengthened making it difficult for US manufacturers to compete internationally and making international goods cheaper for Americans, thus continuing the vicious cycle in which the rest of the world saves and the US, the richest country in the world, consumes more than it produces. 

    Perhaps the much-needed correction will automatically come with the recession. With the US economy in recession, China has lost its biggest customer. In February, China’s exports fell by 26% and trade surplus declined from $31 billion in January to $4.8 billion in February. With its export surplus declining, China will have less money to purchase American debt. 

    As an aside, the Chinese premiere’s outburst was rather refreshing and an indicator of the changing times. It was not too long ago, when China was among a handful of countries that did not have the most-favoured-nation status with the US. Every year, China had to prove to the US its worthiness for obtaining the most-favoured-nation status. Now it seems that it is the US’s turn to please the Chinese government about its creditworthiness. Last month, on her visit to China, secretary of state Hillary Clinton had to publicly assure China of American creditworthiness. Last week, the White House had to give similar assurances. Not that China will ever sell the treasury bonds in any large amount in the market. Doing so will plunge the treasuries market and along with that the value of the Chinese credit.