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China's U.S. Debt Quandary
Gady Epstein 03.19.09, 6:00 PM ET
U.S. investors may have cheered the Federal Reserve's decision this week to pump more than 1 trillion new dollars into the economy, but at least one faction in China was on the verge of tears.
"I want to cry, really want to cry," wrote one Beijinger on Thursday, posting on one of China's most popular portals, Sina.com. The problem was that by issuing more currency, the Fed was potentially weakening the U.S. dollar, making China's dollar-based investments worth less. "Those elites insist on buying American bonds."
One of "those elites" under fire is Premier Wen Jiabao. When he expresses public angst about the safety of China's holdings of U.S. debt, he is speaking partly to domestic critics who believe Chinese leaders have unwisely tied their country's fate to the U.S. economy. Many of the critics may be crackpots and conspiracy theorists, but they have a point.
They know that their government is now America's largest creditor, with more than half of its $2 trillion in foreign exchange reserves invested in Treasury securities and other U.S. government bonds. Some of these critics suspect that the Federal Reserve essentially prints more money not just to stimulate the economy, but also to devalue China's U.S. dollar portfolio, undermining a rival power.
It may be a paranoid theory, but it is a popular one. One of China's bestselling books in the past 18 months is Currency Wars, a conspiratorial screed that suggests that Western financial interests, including the Federal Reserve, seek to destroy the Chinese economy. The book has sold more than 1 million copies officially, and probably several million more pirated copies, and remains a bestseller now as economic conditions deteriorate.
Any leaders who choose to ignore this populist thinking risk being branded as sellouts. Last fall, as the financial crisis was unfolding, an incendiary letter circulated on the Internet claiming that a clique of Chinese elites, led by investment banker and former Premier Zhu Rongji's son Levin Zhu, formed a "foreign financial interest cartel" that has betrayed the interests of the Chinese people to enrich themselves and their cronies.
The letter named as co-conspirators the men running China's $200 billion sovereign wealth fund, whose disastrous investments in the Blackstone Group and Morgan Stanley have lost China billions. People's Bank of China Governor Zhou Xiaochuan, China's Ben Bernanke, was singled out for investing too much in Treasurys as the dollar was depreciating--more reasoning straight out of Currency Wars.
The believers are not just fire-breathing ideologues. "Many technocrats believe in this argument that the U.S. is trying to screw over China by cheapening the dollar," says Victor Shih, a political economist and China specialist at Northwestern University. Shih learned of the influential reach of "Currency Wars" when he visited last summer with bureaucrats from the People's Bank of China.
"Many PBOC officials bought into the arguments of this book and I think they've been writing a lot of reports to Wen Jiabao saying we're holding a lot of dollars and we're exposed to this risk," Shih says. "And essentially that's true."
There's the rub. Almost by accident, the conspiracy theories cut straight to what many economists consider a fundamental weakness in China's monetary policy, and the leadership knows it. China has accumulated huge U.S. dollar reserves to keep the value of its own currency down, economists say, increasing its dependency on exports and decreasing its ability to invest more domestically.
"You're making your economy more dependent on the rest of the world," says Brad W. Setser, an economist at the Council on Foreign Relations who has closely monitored China's sovereign investments. "You're relying on demand from the rest of the world to maintain domestic employment rather than, say, running a fiscal deficit."
Now China is locked into a situation where it needs the U.S. economy to rebound, but as the U.S. spends trillions of dollars to make that happen, it devalues the one currency China is most heavily invested in and pegged against. That forces China to continue buying U.S. dollars both to keep the value of its currency down and to protect its portfolio, so China ends up helping finance the U.S. economic recovery plan.
According to Setser, there is "no good historical analogy" for this situation. Never before has the U.S. been so heavily financed by one country. That relationship has already been the subject of much hand-wringing in the U.S., but it may be an even more volatile political problem for China.
It's the old debtor's aphorism, writ on a sovereign scale: If you owe China $1 billion, it's your problem. If you owe China $1 trillion, it's China's problem.
Gady Epstein 03.19.09, 6:00 PM ET
U.S. investors may have cheered the Federal Reserve's decision this week to pump more than 1 trillion new dollars into the economy, but at least one faction in China was on the verge of tears.
"I want to cry, really want to cry," wrote one Beijinger on Thursday, posting on one of China's most popular portals, Sina.com. The problem was that by issuing more currency, the Fed was potentially weakening the U.S. dollar, making China's dollar-based investments worth less. "Those elites insist on buying American bonds."
One of "those elites" under fire is Premier Wen Jiabao. When he expresses public angst about the safety of China's holdings of U.S. debt, he is speaking partly to domestic critics who believe Chinese leaders have unwisely tied their country's fate to the U.S. economy. Many of the critics may be crackpots and conspiracy theorists, but they have a point.
They know that their government is now America's largest creditor, with more than half of its $2 trillion in foreign exchange reserves invested in Treasury securities and other U.S. government bonds. Some of these critics suspect that the Federal Reserve essentially prints more money not just to stimulate the economy, but also to devalue China's U.S. dollar portfolio, undermining a rival power.
It may be a paranoid theory, but it is a popular one. One of China's bestselling books in the past 18 months is Currency Wars, a conspiratorial screed that suggests that Western financial interests, including the Federal Reserve, seek to destroy the Chinese economy. The book has sold more than 1 million copies officially, and probably several million more pirated copies, and remains a bestseller now as economic conditions deteriorate.
Any leaders who choose to ignore this populist thinking risk being branded as sellouts. Last fall, as the financial crisis was unfolding, an incendiary letter circulated on the Internet claiming that a clique of Chinese elites, led by investment banker and former Premier Zhu Rongji's son Levin Zhu, formed a "foreign financial interest cartel" that has betrayed the interests of the Chinese people to enrich themselves and their cronies.
The letter named as co-conspirators the men running China's $200 billion sovereign wealth fund, whose disastrous investments in the Blackstone Group and Morgan Stanley have lost China billions. People's Bank of China Governor Zhou Xiaochuan, China's Ben Bernanke, was singled out for investing too much in Treasurys as the dollar was depreciating--more reasoning straight out of Currency Wars.
The believers are not just fire-breathing ideologues. "Many technocrats believe in this argument that the U.S. is trying to screw over China by cheapening the dollar," says Victor Shih, a political economist and China specialist at Northwestern University. Shih learned of the influential reach of "Currency Wars" when he visited last summer with bureaucrats from the People's Bank of China.
"Many PBOC officials bought into the arguments of this book and I think they've been writing a lot of reports to Wen Jiabao saying we're holding a lot of dollars and we're exposed to this risk," Shih says. "And essentially that's true."
There's the rub. Almost by accident, the conspiracy theories cut straight to what many economists consider a fundamental weakness in China's monetary policy, and the leadership knows it. China has accumulated huge U.S. dollar reserves to keep the value of its own currency down, economists say, increasing its dependency on exports and decreasing its ability to invest more domestically.
"You're making your economy more dependent on the rest of the world," says Brad W. Setser, an economist at the Council on Foreign Relations who has closely monitored China's sovereign investments. "You're relying on demand from the rest of the world to maintain domestic employment rather than, say, running a fiscal deficit."
Now China is locked into a situation where it needs the U.S. economy to rebound, but as the U.S. spends trillions of dollars to make that happen, it devalues the one currency China is most heavily invested in and pegged against. That forces China to continue buying U.S. dollars both to keep the value of its currency down and to protect its portfolio, so China ends up helping finance the U.S. economic recovery plan.
According to Setser, there is "no good historical analogy" for this situation. Never before has the U.S. been so heavily financed by one country. That relationship has already been the subject of much hand-wringing in the U.S., but it may be an even more volatile political problem for China.
It's the old debtor's aphorism, writ on a sovereign scale: If you owe China $1 billion, it's your problem. If you owe China $1 trillion, it's China's problem.
Pulls all her Money from American 
Banks and Prefers Euro for Trading 
. 
