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The Delicate Dynamics Of China-U.S. Economic Policy

In the autumn of 2008, China became the United States’ biggest creditor, and Chinese leaders have wasted little time in flexing their growing economic muscle. China is demanding a stronger voice in global economic affairs and has proposed a new international currency that would supplant the dollar as the world’s dominant medium of exchange. Should U.S. investors worry about China’s emergence as a powerful economic force? And how will this “new world order” affect American consumers?

The Chinese have been buying up U.S. Treasury bonds for years, and by January 2009, China held $740 billion in U.S. Treasury securities, or 24% of the total outstanding Treasury debt. In September 2008, China had surpassed Japan as the U.S.’s largest creditor. China also has amassed the world’s largest cash reserves, totaling about $1.9 trillion, and maintains the world’s most lopsided trade surplus with the United States. That reflects the fact that China has become the world’s No. 1 producer while America has become a nation of avid consumers. Monies from throughout the world are pouring into China’s booming economy while American dollars flow outward to buy more goods and services.

These trends have led to controversy, with U.S. officials accusing the Chinese government of manipulating its currency to keep its exports competitive. But the Obama administration backed away from those claims early in 2009 after China allowed its currency to appreciate slightly against the dollar, thus slowing the nation’s accumulation of cash reserves.

For now, leaders of both countries have agreed to work together to fight the global recession, joining countries in the European Union and around the world. But in the long run, China is building up a potentially alarming amount of influence over the American economy, analysts say. “The scale of financing the U.S. now receives from China truly is unprecedented: it now not only tops the largest inflow the U.S. ever received from another country, but it is clearly by far the largest inflow the U.S. has ever received from a government that the U.S. doesn’t consider a close military ally,” writes Brad W. Setser, geoeconomics fellow at the Council on Foreign Relations, in his blog for the Center for Geoeconomic Studies. “And I don’t think it is in the interest of the United States to rely so heavily on a single country’s government for financing.”

Chinese leaders have recently expressed concern about the strength of the U.S. economy—and, by extension, the safety of China’s Treasury investments—and signaled a desire to diversify. Should China shift a significant amount of money out of U.S. government bonds, other international and domestic investors could follow the Chinese lead. Any run on Treasury bonds would hurt the U.S. government’s ability to pay for hundreds of billions of dollars in recession-fighting stimulus spending and would increase borrowing costs for U.S. companies and individuals. Such a move could, however, improve the trade deficit, because it would weaken the dollar, making U.S. exports more affordable. Currently, the U.S. imports from China five times as much as it exports to China.

While China cut back on U.S. Treasury purchases earlier this year, analysts agree that at least in the near term, the Chinese will continue to invest in U.S. bonds, both to maintain China’s trade advantage and because the global recession presents few safe investing alternatives. Still, China’s emergence as America’s No. 1 creditor signals a basic change at a time of great economic uncertainty. During past economic downturns, the U.S. was always the largest creditor nation in the world. That was a good position to be in, because it meant other countries owed the U.S. more than it owed them.

During the current global recession, the reverse is true. America has become the world’s largest debtor nation. As long as interest rates stay low, that alone is not a problem. However, as interest rates increase, it will become more expensive for American companies and consumers to borrow money, for everything from business equipment to houses. And that can only make emerging from the recession a longer and more difficult process. To put individual households and the country as a whole on more sustainable footing in preparation for future downturns, Americans will need to make the painful transition from spending to saving more of their hard-earned dollars.

 


This article was written by a professional financial journalist for Legend Financial Advisors, Inc. and is not intended as legal or investment advice.



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