October’s shutdown of the US federal government elicited responses from Chinese leaders and businesses alike. A widely-circulated Xinhua op-ed called for the development of a “de-Americanized world” and China’s Dagong Global Credit Rating made waves by downgrading US treasuries to an A- rating. The People’s Bank of China (PBC) had already decreased its holdings of United States treasuries twice between May and August. China’s intended message to US lawmakers seems clear — get your house in order, or we won’t be investing in the United States for much longer.
On closer examination, these gestures are more for show than anything else. Some American journalists were quick to claim that any piece appearing in the state-run Xinhua News suggests — or even confirms — the official views of the Chinese Communist Party, but the op-ed in question was the work of journalist Liu Chang, whose name was displayed in an unrequired byline. The credit downgrade should prove harmless. Even in breaking with the three other major Chinese credit ratings agencies, Dagong has done nothing bolder than American counterparts like Standard and Poor’s, whose 2011 downgrade had a negligible effect on the United States’ cost of borrowing. China’s sale of US treasuries had the most potential to affect global markets, but this year’s major sell-off amounted to only $29.2 billion from nearly $1.3 trillion in total holdings and was almost completely undone by a purchase of $25.7 billion in September.
As policymakers are beginning to acknowledge, the Sino-US position transcends the simple binary of a creditor-debtor relationship. Although some American conservatives have invoked the nation’s fiduciary duty to China as reason to curb government spending, the United States is not otherwise beholden to Beijing; in fact, a Chinese attempt to pressure Washington with the divestment of US treasuries would likely be welcomed by American economists, including Janet Yellen, who is on track to be confirmed as Ben Bernanke’s replacement as Chair of the Federal Reserve Bank by January.
Ms. Yellen has taken a position on the Fed’s intervention that is seen as even more dovish than Mr. Bernanke’s. For all of his efforts to bolster the economy through quantitative easing, the current Chairman has been criticized for erring on the side of caution at the expense of a more rapid recovery for the United States. Beyond voicing her support for the Fed’s current measures, Ms. Yellen has signaled that she may be prepared to pursue still more proactive policies and that Fed efforts to spur moderate inflation would likely increase under her leadership.
The conclusion to be drawn from these developments is that any appreciable US treasury divestiture by the Chinese would be taken in by the United States Federal Reserve System, which is already purchasing $85 billion in assets monthly — more than seven times the amount that the PBC sold over a three month period. The potential uptick in long-term interest rates on US maturities as a result of decreased demand is also likely to be offset, as the oldest of the baby boomers turn 67 this year and move to fixed-income assets for retirement. The only consequence of a sizable Chinese sell-off would be a dip in the dollar index, which would bolster American exports and begin to alleviate the chronic US current account deficit. A weaker dollar would also erode the value of China’s remaining holdings, so the creditor certainly appears to have more incentive to lend the money than the debtor has for borrowing it. Although the United States cannot prevent China from purchasing publicly-traded debt, it is in Beijing’s best interest to begin the weaning process sooner rather than later, and help is to be found where they may least expect it.
China only overtook Japan as the top holder of American debt recently, and with Japanese holdings approaching $1.2 trillion, the gap is still tight. The Japanese government has increased its position during 2013, and is expected to continue to purchase US treasuries as needed to complement Prime Minister Shinzo Abe’s aggressive policy of monetary expansion. The weakening yen and revitalized Japanese export sector have provided much-needed vindication for the PM’s “Abenomics” policies, but those results are sensitive to a sinking dollar index; Japan would likely be compelled to buy up excess US treasuries if insufficient demand from China caused the dollar to fall. In the short term, at least, China may be able to eschew US treasury purchases without severely altering the dollar-yuan exchange rate — and thereby, the export surplus — by leaving Japan to manage the task of propping up the dollar.
As fortuitous as these circumstances are, Chinese policymakers need to accept a weaker dollar in years to come if they wish the renminbi to be accepted as a global reserve currency. Setting aside obstacles like strict capital controls, a currency in short supply internationally stands little chance of being held in reserve — the renminbi just supplanted the New Zealand dollar in the ranking of most-traded currencies, and still accounts for only 2.2 percent of foreign exchange trading. Major currency swap agreements with South Korea and the EU won’t accomplish much; the only way to make the renminbi truly ubiquitous is for China to run a current account deficit, which would necessitate a considerable appreciation against the US dollar and other major currencies. In short, the de-Americanization of the world and renminbi’s ascension to global reserve currency status will decrease the value of China’s dollar-denominated assets — Chinese leaders must come to grips with their predicament and accept this loss to facilitate the evolution of their economic structure.
Colin Moreshead is a freelance writer living and working in Tokyo. His research focuses primarily on East Asian trade relations and exchange rate policy.