China is not ready to take America's place

Beijing may complain about Washington, but its reliance on American debt stems from the China’s own economic policies

The Chinese sure are doing a lot of worrying these days about the stalemate in Washington. Li Keqiang, China’s Premier, told U.S. Secretary of State John Kerry that he was watching the tussle over raising the government’s debt ceiling with “great attention” in a meeting last week. He has good reason to be concerned. With a stash of nearly $1.3 trillion in Treasury securities, China is the world’s largest foreign owner of U.S. government debt. If U.S. Congress fails to lift the ceiling to allow the government to borrow more by Thursday, Washington may not have enough money to pay its bills, potentially leading to a default. That could sink the value of Treasuries — wiping out a big chunk of Chinese wealth in the process.

That possibility has caused much consternation in China. In a blistering (and highly hypocritical) editorial, state news agency Xinhua blasted what it sees as Washington’s irresponsibility in handling global affairs and called for greater say for developing nations in international institutions like the IMF and a new reserve currency to replace the dollar.

“As U.S. politicians of both political parties are still shuffling back and forth between the White House and the Capitol Hill without striking a viable deal to bring normality to the body politic they brag about, it is perhaps a good time for the befuddled world to start considering building a de-Americanized world,” the commentary recommended. “Such alarming days when the destinies of others are in the hands of a hypocritical nation have to be terminated, and a new world order should be put in place.”

Among the Chinese public, the stalemate in Washington has caused confusion and ire. Why, some Chinese are asking, have our leaders invested so much of the country’s money in a government that seems so dysfunctional? “Bought so much [American debt], now you are under the control of others,” went one typical comment posted on microblogging site Sina Weibo. “We should find out who made this decision and let him take the responsibility.”

The Chinese can blame themselves. Since the earliest days of Chinese economic reform, policies that the government has employed to create growth and exports have also made it dependent on debt issued by the U.S. Treasury. Those policies have generated huge current-account surpluses and gargantuan reserves of foreign currency that have left Beijing no other option but to invest in the U.S.

Chinese policy has generally pushed exports while discouraging imports. By controlling the value of its currency, the renminbi (RMB), to promote exports, China hasn’t allowed its exchange rate to adjust to shifts in trade in a way that would bring balance. Economist Huang Yiping once proffered that policies that reduce prices of land, energy and other costs of production also subsidize exports, and thus contribute to surpluses. Meanwhile, the government’s regulation of interest rates has favored investment and punished savers, suppressing domestic consumption.

The current-account surpluses China has notched over the years have resulted in a vault full of foreign-currency reserves — a staggering $3.66 trillion at last count. Though China’s surpluses have been declining (relative to GDP), the country is still adding to this mountain of foreign currency. In the third quarter, China’s foreign-exchange reserves jumped by the largest amount in more than two years.

To many, this ocean of foreign currency shows China’s economic strength, but at the same time, it is also a financial burden. Chinese policymakers simply don’t have many options when managing these giant reserves, and that has forced them to gorge on Treasuries. The U.S.-government-bond market is deep, liquid and reliable — the perfect (and, arguably, only) place to park all those greenbacks. Sure, the Chinese can switch some of their dollars into other currencies, but there is a limit to that strategy. Dumping the dollar would depress its value, eroding China’s own holdings. The only way for China to wean itself off its Treasury habit is to change its entire economic system.

That, though, is happening slowly. One strategy China is pursuing to lessen its dollar dependence is by promoting its own currency as an alternative to the greenback in global trade and finance. The government has had some success. The European Central Bank and China’s central bank recently agreed to a large swap of their currencies. And according to a recent survey from the Bank for International Settlements, the RMB entered the list of top 10 most traded currencies for the first time. Yet in order for the RMB to become a true rival to the dollar, China has to undertake far more reform.

The RMB isn’t fully convertible, nor does it trade freely around the world like the dollar, euro or yen. China is taking stabs at the sort of financial liberalization that would give the RMB an international boost — experimenting with freer capital flows in a new zone in Shanghai, for instance — but those steps are tentative at best. The Chinese government is still reluctant to throw open its financial sector and loosen capital flows and currency trading in a way that would turn the RMB into a solid reserve currency like the dollar.

“China’s policymakers remain deeply uncomfortable with allowing market forces a say in determining the exchange rate at times of uncertainty,” research firm Capital Economics said in a report on Monday. “Policymakers still see opening of capital controls as an important goal. But their actions underline that it remains a long way off.”

What this all means is that China and the U.S. Treasury remain locked in an embrace from which it is very hard for Beijing to escape. What it will take is extensive reform to China’s own economy that so far Beijing has been reluctant to undertake. So Beijing can call for a “de-Americanized world” all it wants. China is not ready to take America’s place.