Whenever the subject of China arises, the issue of Beijing’s ownership of 21.9% of foreign-held U.S. Treasury securities (May 2010 figures) immediately is mentioned. Supposedly this factor provides China with considerable leverage over the United States, even though Japan holds 19.8%. In fact, depending on the extent of pain Washington is willing to inflict on the American financial scene, the U.S. need not be overly worried. It’s China that is in the position of greater vulnerability.
To begin with, China is well aware that it has no substantial alternative to its exports to the United States that, for example, amounted to $297 billion for the year 2009, approximately one quarter of the value of all its worldwide exports for the same year. And this figure was down from the previous year. The first thing that would occur on the occasion of China’s refusal to accept any more Treasury securities — or even a severe limitation of such — would be a requirement by Washington to make serious changes to balance the government budget. Such action clearly would firm the value of the dollar.
While such an increase in dollar value adds to the overall market value of U.S. securities held by the Chinese, it also reduces the current yield of the instruments that are held. Beijing then might seek to sell these valuable instruments, but as they have a coupon value substantially reduced, there wouldn’t be many takers. Better for China just to hold on to the U.S. paper until maturity. No leverage there.
If the Chinese just stop buying U.S. government securities and Washington succeeds in taking successful steps toward a balanced budget, the American stock markets would be expected to rise substantially, providing major cash inflows for publicly traded industries, pension plans, and —tax revenue. That’s the optimistic side of the prognostication.
More realistic would be the natural rise of interest rates acting as a brake on some sectors of the U.S. economy. All in all, however, the impact of a major reduction in China’s purchasing of U.S. Treasury securities might be just the shock needed to force serious cutbacks in U.S. Government spending. Does Beijing really want to aid the American economy to that degree?
What the Chinese have to do in any scenario is work toward bringing greater investment to development of the predominantly rural western half of their country. Here is where the need is most obvious when it comes to empowering a rising consumer base, the key to China’s economic future. So far they have made the right sounds, but serious sustained action is lacking due to internal political disagreements over where development emphasis should be placed.
The figure of 36% of GDP generally has been used to characterize Chinese dependency on foreign trade. That large figure would be far less if Beijing had taken serious steps to enlarge its consumer base presently only equal to a single major member of the European Union even though China has a population of 1.3 billion. (600 million — urban and 700 million – rural).
The fact is, however, that the cities of coastal China have been modernized often to the point of extravagance and 21st century creativity at the expense of traditional cultural values and social cohesion. Their luxurious architectural appointments have given new meaning to Gordon Gekko’s theme of “greed is good.”
Rural China meanwhile lives in traditional poverty and 19th century housing and transport conditions. Migration of the youth eastward to the coasts has become a natural passage of life — as has their devastatingly disappointed return back west. Rural unemployment figures are completely clouded by the lack of reliable statistics, but the to- and- fro movement of millions of rural youth unmistakably tells the story.
With this situation as the background to a summer of far too public disagreement between China and the United States over the value of China’s currency, the renminbi, there has been a well-reported recent effort by Beijing to lower the decibel level of conflict over financial issues. Unfortunately, the reasons behind the effort to seek a lowered tone are less economic than strictly political.
The Chinese appear to have no real interest in pressing on with an American-desired exchange rate reform leading to an appreciation of the officially recognized value of the renminbi. Last June Beijing announced it “would allow greater flexibility” (as the N.Y. Times optimistically put it), but then the Chinese government played its usual game of working the international markets to keep its currency from a speedy rise that would injure Chinese export product competitiveness.
China’s president, Hu Jintao, however, is looking forward to a state visit to Washington in early 2011 prior to his own leaving office the next year. The Chinese may be willing to toss a bone to the American administration in the form of further utterances regarding their currency flexibility. But as Foreign Ministry spokeswoman, Jiang Yu, said in her excellent English, “Our exchange rate reform can’t be pressed ahead under external pressures.”
To participate in this game of international financial poker, Washington had better come up with some smarter players than Larry Summers, director of the National Economic Council, recently negotiating in Beijing and now returning to Harvard. The Chinese, who always take a longer view, are undoubtedly gauging their next move in terms of how long they may have to deal with the Obama administration. Washington had better be thinking about what they are going to do with Beijing post-Hu Jintao.