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As of January this year, China held US$739 billion of the U.S. Treasury debt. It cannot afford to buy more. The domestic situation is precarious: exports fell 25 percent in the last two months and unemployment is spiraling. The government is pumping huge sums into infrastructure projects to stave off social unrest.
Still, the United States is hoping to be the sole depository for China’s 2009 export earnings. That is what Clinton was indirectly asking.
The financial meltdown is causing deleveraging by both U.S. businesses and private citizens. The vaulted era of leveraged buyouts by businesses and uncontrolled consumer spending is over. Only the U.S. government, in the name of stimulus packages, has decided to spend its way out of recession. Its argument is that without this spending, 10 million people could be out of work.
Hence China comes to mind. China has two types of money at its disposal – high domestic savings, which could be pumped into its own economy, and a huge trade surplus, which could be used to lend money to the needy – such as the United States and Europe.
U.S. government debt to China is tied down in U.S. Treasury bonds and is not cashable. China has a total of US$1.8 trillion in worldwide reserves, 65 percent of it in U.S. currency. The Chinese consider the disposition of their reserves a state secret, hence the known information is incomplete.
It is known that at the end of 2007 China had about US$120 billion in mortgage-backed securities, or subprime loans, and $200 billion in sovereign funds, in addition to its U.S. Treasury bonds. This huge investment gives China a geopolitical advantage; but if the debtor cannot pay, it is a serious concern.
China’s huge reserves are the result of uncontrolled U.S. imports, the low value of the Chinese currency, and the huge amount of foreign investment into China. Cheap labor is another factor. If the U.S. largesse is withdrawn, China’s exports and the value of its reserves will collapse. The Chinese understand this weakness, and are prepared to go along with U.S. requests. They may have concerns, but these will be swept aside in the geopolitical game now in progress.
At home the Chinese are suffering a major economic depression, though they are not willing to accept it. If China’s GDP growth falls below 8 percent, the political repercussions could be great. The magic 8 percent growth number has been arrived at by calculating year-on-year manpower growth and the economic activity needed to keep the workforce busy.
The leadership rightly fears that widespread unemployment could spell doom for the communist state. Hence they need their money at home much more urgently than they need to help out the United States. Still, Clinton managed to extract an assurance of continued Chinese support for U.S. debt.
If China suffers a 10 to 15 percent drop in exports in 2009 and again in 2010 as a result of a 4 to 6 percent contraction in the U.S. GDP, it is quite possible that China will be unable to attain the projected 8 percent growth rate. In a country where 65 percent of national output is exported, this is certainly possible.
Therefore, China needs to transfer its reserves back home. Yet the United States is in no mood to hand it over. The result could be bigger and bigger clashes between the two countries. A protectionist-minded U.S. Congress might try to force up the value of the yuan, or apply 15 to 20 percent countervailing duties on Chinese imports – and the first shot of a trade war would be fired.
The United States could forestall a trade war by bringing home some of the manufacturing it has lost to China. This would put a damper on Chinese exports and avoid countervailing duties.
If no rash actions are taken and an orderly approach is adopted, still something must be done to cut the growing U.S. trade deficit with China. Here are some suggestions for both sides:
– The United States could keep artificial prosperity in check by cutting consumption and controlling the money supply – consuming less oil and fewer consumer goods and making less money available to businesses and consumers.– The Chinese could save less and spend more domestically. This could be a boon to goods and services suppliers in the West, and trade could move toward a balance in a few years.
– The dollar-yuan relationship could be slowly revised so that China’s vast holdings are reduced and Chinese exports do not have an unfair advantage.
– The Chinese could concentrate on buying more U.S. goods.
If these actions are taken during the current recession, the net outcome would be a more secure trade and geopolitical relationship.
If China decided to dump its U.S. dollars it would have to come up with an alternative to hold its vast reserves. But there is no suitable alternative for the time being.
It is not likely that U.S. President Barack Obama can do all of the above, however. He has already taken too many initiatives at home. Alternatively, the U.S. Congress may force the China trade issue with the Obama administration.
Obama’s political capital is slowly being spent. The Republican Party has already convinced a significant number of people that his stimulus package is the wrong way to go. Its main point is that ultimately the U.S. government will have to pay back all the money it borrows, leaving the economy significantly weaker. Hence the stimulus money is a net waste.
It is also unlikely that the Chinese will do anything about their money in the United States. That money will stay where it is until the current world economic order breaks down and a new economic center of gravity emerges. By that time the money will be worthless anyway.
The Chinese are hoping the United States will continue to import at least as much as it is doing now. That will keep 120 million of their workers employed. They are also hoping the dollar-yuan value will not be altered. Any change would be bad news for China, but also for the United States, as China’s export deposits would decrease.
This is a Catch-22 situation for both the United States and China. There is wisdom in our grandparents’ economics – spend what you have, not what you don’t have. Also, build tangible assets with surplus cash, not intangibles like securities, bonds, hedge funds and derivatives. The United States may be forced to adopt this approach to pull out of its current economic mess.
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(Hari Sud is a retired vice president of C-I-L Inc., a former investment strategies analyst and international relations manager. A graduate of Punjab University and the University of Missouri, he has lived in Canada for the past 34 years. ©Copyright Hari Sud.)
