Debt Crisis Raises China Questions

The debt crisis in the U.S. also exposes Beijing's 'skewed' financial policies.
By Parameswaran Ponnudurai
2011-08-04
Email story
Comment on this story
Share story
Print story
  • Print
  • Share
  • Comment
  • Email
china-exports-305.gif
Cranes lift containers at Waigaoqiao Port, Shanghai, April 24, 2011.
ImagineChina

China may have grounds to criticize the United States for its massive debts but it still needs to do some soul searching over its financial policies, which experts say allow the Asian giant to expand rapidly at the expense of other countries.

Being the biggest foreign creditor of the United States, holding more than U.S. $1 trillion in American government debt, Beijing has been a vociferous critic of U.S. debt management policy.

After the U.S. Congress averted what would have been a catastrophic debt default for the world's biggest economy this week, Chinese state-run Xinhua News Agency blasted the “madcap” brinksmanship of American lawmakers.

"The months-long tug of war between Democrats and Republicans ... failed to defuse Washington's debt bomb for good, only delaying an immediate detonation by making the fuse an inch longer," said the blistering commentary by Xinhua, which often reflects the feelings of the country’s political elite.

As Western rating agencies such as Moody's and Standard and Poor's decided to leave the United States with its top AAA rating, China's Dagong Global Credit Rating lowered its rating on U.S. sovereign debt.

The Chinese central bank also weighed in on the emergency bill approved by lawmakers and which President Barack Obama signed into law on Tuesday to raise the U.S. debt limit and avoid a government default.

Washington must keep in mind the interests of the rest of the world and, in particular, U.S. Treasury bonds, of which China is the largest holder, said People’s Bank of China governor, Zhou Xiaochuan.

While the criticism is understandable—China's holding of more than a third of its massive $3.2 trillion foreign exchange reserves in U.S. Treasuries make it among the most immediately affected by any U.S. default—Beijing has a global duty to revamp its skewed policies too, experts say.

China knows too well that its options for diversifying from dollar-based assets are very limited as there are few markets in the world outside the U.S. that are deep or liquid enough to handle its massive foreign-exchange purchases.

So has it done enough to ease the accumulation of its export-driven foreign reserves?

"What they really should be doing is taking the appropriate monetary and exchange rate policies that would lead to less accumulation of reserves," Nicholas Lardy, a China expert at the Washington-based Peterson Institute for International Economics, told RFA.

"They are still accumulating reserves—about U.S. $150 billion a quarter. Now there are over U.S. $3 trillion. It won't be long before there are over U.S. $4 trillion unless they make some very fundamental changes," he said.

Currency manipulation

china-us-debt-400.gif
Chart shows the proportion of the U.S. debt held by China and others.

China has been constantly accused by the United States and other key economies of manipulating its yuan currency rate. It does so by purchasing dollars entering the economy to depress the yuan against the greenback in a bid to make Chinese exports more competitive.

Lardy said China has been dragging its feet on phasing in concrete exchange rate reforms.

The yuan has risen more than 6 percent against the U.S. unit since June 2010, when Beijing effectively ended its currency's two-year-long peg to the dollar and vowed to make the yuan more flexible.

Still, if the currency movement is adjusted for the difference between inflation and inflation among trading partners, there appears to be no yuan appreciation.

"The [yuan] exchange rate over the last two years has not appreciated at all on a real trade-weighted basis—the quarterly reserve build up is still massive, unprecedented," Lardy said.

Ramping up efforts to reform currency policy can be politically sensitive in China, whose exports drive jobs.

"[T]he [yuan]’s value is widely perceived to be a key factor in managing competitiveness of an export sector that is a strong source of new GDP growth and employment, the sine qua non of domestic political stability in the view of most Chinese leaders," said Charles Freeman, a China expert at the Washington-based Center for Strategic and International Studies.

Many export businesses are based in wealthier communities in coastal China—a more privileged and politically volatile group of Chinese society, he said.

Undervalued

The yuan is undervalued by 28.5 percent against the U.S. dollar, according to a recent study by the U.S.-based Economic Policy Institute (EPI), an independent think tank.

Because Beijing keeps its currency low to boost exports, other key Asian economies such as Hong Kong, Taiwan, Singapore, and Malaysia also follow suit to maintain their trade competitiveness, it said.

If the yuan and the other Asian currencies were revalued to their "equilibrium" levels, U.S. gross domestic product (GDP) would increase as much as U.S. $285.7 billion (nearly 2 percent), creating up to 2.25 million U.S. jobs, the study showed. These benefits would be achieved in 18 to 24 months, it said.

“It’s in the interest of both the United States and China to let the yuan appreciate,” said Robert Scott, the institute's director of trade and manufacturing policy research who compiled the report.

From the U.S. point of view, he said, a yuan revaluation would mean increased GDP, more jobs, lower unemployment and reduction of the government deficit by up to U.S. $857 billion over 10 years.

For China, the move will lower inflation, raise the purchasing power of Chinese workers, and help rebalance their economy, he added.

China's consumer price index, the main gauge of inflation, rose 6.4 percent in June from a year earlier, its fastest pace in three years, forcing the central bank to raise benchmark lending and deposit rates thrice this year to counter rising prices.

China has also been taken to task for not doing enough to make its economy less dependent on exports and stoke domestic consumption as part of a global growth rebalancing strategy.

"I think the main problem is that they are continuing to rely primarily on financial repression, which reduces household income, causes households to save more, so that consumption as a share of GDP is extraordinarily low and not rising," Lardy said.

He noted that China's domestic consumption as a share of GDP continued to fall in 2010.

"I think the key thing to watch for going forward, if they really are going to do anything about this, is more domestic interest rate liberalization and more flexibility on the exchange rate."