Yes, the United States dodged another bullet with a last-minute deal on the debt ceiling. But, with 90 days left to bridge the ideological and partisan divide before another crisis erupts, the fuse on America’s debt bomb is getting shorter and shorter. As a dysfunctional US government peers into the abyss, China – America’s largest foreign creditor – has much at stake.
It began so innocently. As recently as 2000, China
owned only about $60 billion in US Treasuries, or roughly 2% of
the outstanding US debt of $3.3 trillion held by the public. But then both
countries upped the ante on America’s fiscal profligacy. US
debt exploded to nearly $12 trillion ($16.7
trillion if intragovernmental holdings are included). And China’s
share of America’s publicly-held debt overhang increased more than five-fold,
to nearly 11% ($1.3 trillion) by July 2013. Along with roughly $700
billion in Chinese holdings of US agency debt (Fannie Mae and Freddie Mac),
China’s total $2 trillion exposure to US government and quasi-government
securities is massive by any standard.
China’s seemingly open-ended purchases
of US government debt are at the heart of a web of codependency that binds
the two economies. China does not buy Treasuries out of benevolence, or because
it looks to America as a shining example of wealth and prosperity. It certainly
is not attracted by the return and seemingly riskless security of US government
paper – both of which are much in play in an era of zero interest rates and
mounting concerns about default. Nor is sympathy at work; China does not buy
Treasuries because it wants to temper the pain of America’s fiscal
brinkmanship.
China buys Treasuries because they suit its
currency policy and the export-led growth that it has relied on over the past
33 years. As a surplus saver, China has run large current-account surpluses
since 1994, accumulating a massive portfolio of foreign-exchange reserves that
now stands at almost $3.7 trillion.
China has recycled about 60% of these
reserves back into dollar-denominated US government securities, because it
wants to limit any appreciation of the renminbi against the world’s benchmark
currency. If China bought fewer dollars, the renminbi’s exchange rate – up 35%
against the dollar since mid-2005 – would strengthen more sharply than it
already has, jeopardizing competiveness and export-led growth.
This arrangement fits America’s needs like
a glove. Given its extraordinary shortfall of domestic saving, the US runs
chronic current-account deficits and relies on foreign investors to fill the
funding void. US politicians take this for granted as a special privilege
bestowed by the dollar’s position as the world’s major reserve currency. When
queried about America’s dependence on foreign lenders, they often smugly
retort, “Where else would they go?” I have heard that line many times when I
have testified before the US Congress.
Of course, America benefits from China’s
outward-facing growth model in many other ways, as well. China’s purchases of
Treasuries help hold down US interest rates – possibly by as much as one
percentage point – which provides broad support to other asset markets, such as
equities and real estate, whose valuation depends to some extent on
Chinese-subsidized US interest rates. And, of course, hard-pressed middle-class
American consumers benefit hugely from low-cost Chinese imports – the Walmart
effect – that enable them to stretch their budgets in an era of unrelenting
pressure on jobs and real incomes.
For more than 20 years, this mutually
beneficial codependency has served both countries well in compensating for
their inherent saving imbalances while satisfying their respective growth
agendas. But here the past should not be viewed as prologue. A seismic shift is
at hand, and America’s recent fiscal follies may well be the tipping point.
China has made a conscious strategic
decision to alter its growth strategy. Its 12th Five-Year Plan, enacted in
March 2011, lays out a broad framework for a more balanced growth model that
relies increasingly on domestic private consumption. These plans are about to
be put into action. An important meeting in November – the Third Plenum
of the Central Committee of the 18th Chinese Communist Party Congress – will
provide a major test of the new leadership team’s commitment to a detailed
agenda of reforms and policies that will be required to achieve this shift.
The debt-ceiling debacle has sent a clear
message to China – and comes in conjunction with other warning signs.
Post-crisis sluggishness in US aggregate demand – especially consumer demand –
is likely to persist, denying Chinese exporters the support they need from
their largest foreign market. US-led China bashing – a bipartisan blame game
that reached new heights in the 2012 political cycle – remains a real threat.
And now the safety and security of US debt are at risk. Economic alarms rarely
ring so loudly. The time has come for China to respond with equal clarity.
Rebalancing is China’s only option. Several
internal factors – excess resource consumption, environmental degradation, and
mounting income inequalities – are calling the old model into question, while a
broad constellation of US-centric external forces also attests to the urgent
need for realignment.
With rebalancing will come a decline in
China’s surplus saving, much slower accumulation of foreign-exchange reserves,
and a concomitant reduction in its seemingly voracious demand for
dollar-denominated assets. Curtailing purchases of US Treasuries is a perfectly
logical outgrowth of this process. Long dependent on China to finesse its
fiscal problems, America may now have to pay a much steeper price to secure
external capital.
Recently, Chinese commentators have
provocatively referred to the inevitability of a “de-Americanized world.” For
China, this is not a power race. It should be seen as more of a conscious strategy
to do what is right for China as it confronts its own daunting growth and
development imperatives in the coming years.
The US will find it equally urgent to come
to grips with a very different China. Codependency was never a sustainable
strategy for either side. China just happens to have understood this first. The
days of its open-ended buying of Treasuries will soon come to an end.
