China won't torpedo the economy by dumping our bonds.
FROM THE WALL STREET JOURNAL | MAY 28, 2009
Twenty years ago, in the wake of the suppression of the student movement that had taken over Tiananmen Square, it seemed as if China's brief opening to the world had come to an end. In fact, 1989 marked the beginning of China's supercharged path to economic reform. The results have been tremendous: China is now the second pillar of the global economy and is increasingly vital given the vulnerability of the United States.
The U.S. now relies on China for credit, a fact that is generating considerable anxiety in Washington and Beijing. Last month Chinese Premier Wen Jiabao called for more international oversight of the world's major "reserve" currencies. While he didn't specifically mention the U.S. dollar, the message was clear. As the largest holder of U.S. debt, the Chinese government is restless as the $2 trillion in foreign reserves it holds fluctuates primarily based on the management -- or mismanagement -- of American financial institutions.
Mr. Wen's comments, as well as more recent statements by other Chinese officials, constitute a series of not-so-subtle hints by China that it intends to take a more active approach toward its substantial investments in the U.S. Given that China is now the largest holder of U.S. Treasurys and the largest foreign creditor of the U.S. government -- to the tune of approximately $1 trillion in government securities alone -- the recent statements by Chinese officials have caused serious American trepidation.
Unease about China's economic clout is not new. During his presidential campaign in 2004, John Kerry waged a rhetorical assault on the "Benedict Arnold CEOs" who outsourced their company's workforce to China. In 2007, Sens. Charles Schumer of New York and Lindsey Graham of South Carolina found common ground in threatening China with punitive tariffs because of accusations of currency manipulation that gave it an unfair trade advantage. The current financial crisis has accelerated such concerns, even as China's willingness to purchase U.S. debt has allowed the Obama administration to commit to unprecedented levels of spending.
The most commonly expressed fear is that China could use its status as the largest foreign creditor to pressure the U.S. to take positions it would not otherwise take. What if China wants to adopt a harsher stance towards Taiwan? Or what if it refuses to pressure North Korea to halt its nuclear-arms program?
To many, that fear seemed justified when Treasury Secretary Timothy Geithner -- who will be in China next week -- recently refused to label China a "currency manipulator." This led to an immediate outcry on the part of Messrs. Schumer and Graham that the administration was succumbing to Chinese pressure. That in turn fueled the already rampant speculation that China now holds the equivalent of a Sword of Damocles over the U.S.: Do what we say or we'll dump your bonds.
Worries about China's ascendancy have not been confined to either party. Fiscally conservative Republicans are just as apt to raise eyebrows about dependency on China as Democratic labor leaders. While this is a rare area of bipartisan accord, it is also an area of bipartisan error.
To begin with, China cannot simply decide one day to "dump its bonds" and torpedo the U.S. economy. It can't even credibly threaten to do so because it has no one to sell them to. Who in today's world could buy $1 trillion of U.S. debt? What government could take the risk of further enmeshing itself in an American economy that is widely seen as having drawn the global system into an untenable dependence on low-grade debt? The German central bank certainly wouldn't, nor would Japan, which already holds hundreds of billions in U.S. debt. The sovereign wealth funds of the oil-rich Arab sheikhdoms, including Saudi Arabia, have already taken hits with their investments in U.S. financial institutions and are wary of further depreciation of their oil-dependent assets.
But even if there were buyers, the issue is deeper than economics. China's investments in the U.S. are as much a political decision as an economic one. They represent the culmination of two decades of assiduous efforts on the part of the Chinese government and many U.S. companies to bind the two economies together.
Until recent months, the common understanding of the relationship between China and the U.S. was that China produced cheap stuff that Americans bought. But that was always just one aspect of a much more intertwined relationship, one that entails significant growth for U.S. companies as they sell to Chinese consumers and provide support for China's industrial build-out. The Chinese government has actively tethered its economic and political stability to the U.S.
To some degree, China's holdings prove the old adage: If a bank lends you $1 million, you've got a problem; but if a bank lends you $10 million, the bank has a problem. With so much invested in the U.S., China can no more tolerate a severe U.S. implosion than Americans can. Any action taken by China to imperil the economic stability of the U.S. would be an act of mutually-assured destruction.
To see China's holdings as a threat is to misjudge the goals of the Chinese government. China believes that its affluence is best guaranteed by economic interdependence with the world's most dynamic economy. It certainly wants to evolve so that its affluence is eventually comparable to that of America, but that is years away. And while there is a competitive component to China's ambitions, it is competition within the framework of capitalism more than nationalism.
True, some Chinese question the intimate connection to the U.S., just as many Americans bristle at the large Chinese stake in our economy. But the fact is that without China lending, the financial crisis would be markedly worse. And without the know-how of U.S. companies and the considerable market that even a hobbled U.S. offers, China would not be weathering the storm as well as it currently is.
The challenge going forward is to see benefit rather than threat in the U.S.-China relationship, and to understand that the path to continued prosperity in the 21st century will not look the same as it did in the 20th century. It is a path that will be constructed on the fusion of the Chinese and American economic systems -- not the predominance of either.