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Home > Blogs > Ian Fraser > Beijing unlikely to go MAD any time soon

Beijing unlikely to go MAD any time soon

Finance Blogger: Ian Fraser Ian Fraser

Americans (some Americans anyway) remain deeply anxious about China’s ownership of $1–2 trillion of their country’s debt. The fears that these massive holdings leave the US vulnerable and exposed intensified on February 15 when it was reported Beijing had dumped some $34.2 billion of US Treasury bills.

There are fears, for example, that Beijing might suddenly offload its circa $1.5 trillion holding of Treasury bills and, in so doing, spark an economic version of mutually assured destruction (MAD).

It’s quite common for North Americans to believe this. They suspect their government has inadvertently handed the Chinese a weapon of economic war, with which the People’s Republic could undermine the dollar, necessitate higher US interest rates and destabilize Uncle Sam’s economy. There’s also a suspicion that China might use its position as lead creditor to dictate American policy and make it more difficult for the US to finance its massive twin deficits.

Well, Michael Schuman, a financial blogger in Time’s “Curious Capitalist” blog has debunked such notions. He refers to the testimony given by Eswar Prasad, an economist at Cornell University and a senior fellow at the Brookings Institution, to the US–China Economic and Security Review Commission (USCC) on February 25.

Prasad acknowledges that China is, theoretically speaking at least, in a position to sell down its holding of Washington’s bonds, and that it could do so with few long-term consequences for China’s economy. He dismisses three of the popularly cited barriers to such a fiscal decision.

In his testimony to the USCC, Prasad said: “Any Chinese threat to move aggressively out of Treasuries is a reasonably credible threat as the short-term costs to the Chinese … are not likely to be large.”

Prasad also pointed out that China is, in overall terms, less important to the US’s deficit financing than some analysts imagine. He pointed out that the People’s Republic currently owns just 9%–10% of total US government debt. Even if China’s holdings are higher than the reported official data suggest, Prasad says China has “a significant, but not overwhelming, share.”

So what is stopping China from offloading its Treasury bill holdings? According to Prasad, one of the biggest barriers is the lack of available alternatives. Where else could the country safely invest its massive annual surpluses of $300 billion or more? Where else, other than T-Bills could it find that was sufficiently safe, deep, and liquid?

There have been suggestions that China might pursue higher returns by diversifying into private equity via sovereign wealth funds—or even through a Harvard and Yale-style foundation employing diversified global investment strategy. However some analysts doubt whether this is a realistic alternative.

Time’s Shuman argues that China has much more to lose than to gain by making any dramatic shift out of US Treasuries—however he did warn this may change. “As long as China continues to strive for ways to diversify its currency reserves and investment holdings, combined with its efforts to internationalize the yuan, the risk that would come with [dumping T-bills] is likely to decrease over time.”

There is disagreement as to exact quantity of T-bills that Beijing actually owns. The US Treasury, led by Tim Geithner, claims the figure is $755 billion. However Simon Johnson, former International Monetary Fund chief economist said Beijing believes the figure is more like $1 trillion.

Prasad told the commission that some $2.4 trillion of China’s reserves are in dollar-denominated bonds with $1.32 trillion in T-notes … or 17% of outstanding US public debt.

David Wyss, chief economist at Standard & Poor’s in New York, has said: “China may not be too happy with us right now, but you have to ask: what else are they going to do with their money?”

Further reading for China and US debt

Tags: China , global imbalances , private equity , sovereign debt , US
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