Opinion & Commentary
China between T-bills and a hard place
Testimony by former IMF chief economist Simon Johnson to the US-China Economic and Security Review Commission that China could be purchasing tens of billions of US bonds through intermediary institutions in London and Hong Kong is creating consternation in Washington. If true, Beijing could be holding up to US$1 trillion worth of US Treasury bonds. This gives Beijing a theoretical economic ‘weapon of mass destruction’: the option to stop buying or even dump US bonds which would cut off America’s credit and cause the US dollar to go into freefall. For many Republican and Democrat members of Congress, Beijing’s leverage over a deeply indebted superpower appears decisive. But in reality China’s capacity to land genuine blows to the American economy is severely constrained.
To be sure, Beijing views economic warfare as a legitimate tactic against a strategic competitor. For example, China’s official news agency Xinhua reported Major Generals Zhu Chenghu and Luo Yuan and Senior Colonel Ke Chunqiao calling for broad retaliation against recent US transgressions such as its arms sales to Taiwan and President Barack Obama meeting the Dalai Lama. Urging a ‘strategic package of counter-punches covering politics, military affairs, diplomacy and economics’, and an ‘attack by oblique means and stealthy feints’, these strategists recommended the ‘dumping of US bonds’ as one way to demonstrate China’s rising national strength’.
Of course, the dumping of T-bills would significantly devalue Beijing’s international assets. But it is not just the case that America and China are both locked in an economic version of a Chinese finger trap.
Even if Chinese entities are secretly buying bonds through foreign intermediaries, a little known fact is that the proportion of US government debt financed by Chinese foreign exchange reserves has been falling significantly since 2008. For example, China apparently purchased around US$100 billion worth of T-Bills in 2009. This is a lot of IOUs but with a US federal government deficit of US$1.4 trillion, China (similar to Japan) is bankrolling only around 7% of the Obama administration’s deficit.
There is a further reason why China does not actually have an economic WMD at its disposal: it has no choice but to buy low yielding US bonds. Indeed, the willingness of China to purchase US bonds at weekly auction markets shows no correlation with peaks and troughs in the US-China relationship. There are two related reasons for this.
China’s foreign exchange reserves – well over US$2 trillion – is the direct result of its trade surpluses, especially with the US. However, China is the only major economy that pegs its currency to a US dollar dominated ‘basket of currencies’. To maintain this peg – and effectively artificially suppress the value of the yuan vis-à-vis the US dollar – the Chinese Central Bank is forced to continually buy US dollar assets.
China briefly experimented by allowing its currency to rise 21 percent against the US dollar from 2005 -2008 before Party officials and exporters insisted on putting an abrupt stop to it. Experts estimate that the yuan is still between 25% to 50% undervalued vis-à-vis the dollar. The export sector generates well paid jobs for hundreds of millions of Chinese, picking up the slack created by the poor performance of the overwhelming majority of the 120,000 odd state-owned-enterprises. Compared to the private sector in China, these SOEs are two to three times less efficient at generating employment. Allowing the free conversion of US dollars into yuan would cause a rise in the value of the Chinese currency and a significant decrease in the price competitiveness of Chinese exports.
Furthermore, restrictions on converting foreign currency (mainly US dollars and Euro) back into the yuan means that Beijing is left with a huge pile of foreign currency that it needs to ‘park’ somewhere outside China. The American economy is the only location that is big enough and secure to absorb the enormous surpluses that China is generating.
The upshot of all of this is that Beijing’s economic choices are limited, and its leverage over America is far weaker than is commonly portrayed. In fact, even if Beijing correctly worries about the size of the American deficit, it can do little else but continue to buy US dollar assets. Meanwhile, Washington should not underestimate its own leverage. If China wants to give America a bloody nose, its brittle fist might very well shatter in attempting to deliver the blow.
Dr John Lee is a foreign policy fellow at The Centre for Independent Studies in Sydney, and a visiting fellow at the Hudson Institute in Washington, D.C. He is the author of Will China Fail? (CIS, 2009).
