China Likely to Hold U.S. Investments Despite Credit-Rating Downgrade
China used Friday’s downgrading of U.S. debt to renew its complaints about fiscal policy and express growing disillusionment with the American economic model. But it isn’t likely to cut its holdings or purchases much very soon.
Breaking a long silence over Congress’ gridlock on how to deal with the nation’s debt problem, top Chinese economic policymakers have publicly criticized the U.S. over the past few days, warning that Washington must sharply reduce its foreign debt and that America must live within its means.
“The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone," wrote Xinhua, the state-run news service on Saturday, after Standard & Poor’s announced it was lowering its AAA rating for U.S. Treasury debt one notch to AA+.
China is one of America’s most important economic partners. It already holds some $2 trillion in Treasury bonds and other government-backed securities, making it the largest foreign holder of American debt. It has amassed $3.2 trillion in foreign exchange reserves, most of it in U.S. dollars. And it’s the U.S.’ second-largest export market.
Beijing’s relationship with Washington worsened markedly after the onset of the 2008-2009 recession. After openly admiring America’s economic leadership before, top Chinese officials clearly were appalled at the collapse of the U.S. financial system in late 2007—and blamed Washington policymakers for letting it happen.
The resentment quickly spread to other foreign policy issues. China adopted a more belligerent tone in its U.S. dealings, excluded President Obama from a key negotiation at the 2009 Copenhagen climate change conference, broke off U.S.-Chinese military ties and lashed out at America’s prosecution of routine trade complaints.
This time, Beijing had been quiet during the first weeks of congressional wrangling over the debt ceiling. Partly, it was to protect China’s own financial holdings. If China had openly pulled away from its U.S. investments in the face of a possible default, it could have sparked a global run from U.S. securities, devaluing China’s own portfolio.
For now, there’s little likelihood that China will start dumping its holdings of Treasury bonds—or turn sour in its dealings with the U.S. on other key foreign policy issues—even if the new congressional budget compromise fizzles or other credit rating agencies join S&P in downgrading America’s credit rating.
For one thing, a Chinese flight from U.S. securities would quickly devalue China’s own cache of Treasury bonds and dollar holdings. Better to wait until the expected turmoil in global financial markets plays itself out and see what the situation in the global markets looks like.
Even if the U.S. fiscal situation continues to deteriorate, China has nowhere else to go to invest its huge hoard of dollars. No other country has financial markets that are as large, as deep or as liquid as those of the U.S. And Europe and Japan are undergoing tough times as well.
Although China has been grousing for years that U.S. financial markets are too volatile and that it needs to diversify its dollar-denominated portfolios, so far there’s been no evidence that China has begun pulling away from U.S. securities. This past week’s criticisms from China were relatively mild, almost pro forma in their wording.
Moreover, the overall relationship between the U.S. and China is far more stable than it was in late 2007. That makes it unlikely that China’s frustration over the debt ceiling outcome will spill over into broader foreign policy issues, such as the geopolitical rivalry or economic and trade disputes.
Although there’s still a good bit of uncertainty over the role that each country will play as a power in Asia, the two have begun working together again to help restart talks with North Korea. They’ve eased tensions over several key trade issues. And they’ve resumed contacts between their respective military high commands.
With a new regime slated to assume power next year, the outgoing Chinese government doesn’t want to stir up questions at home about why its own top policymakers didn’t see the American debt ceiling debacle coming (and why China continued to invest in dollar-denominated securities).
China also has a full platter of problems to worry about at home. Inflation has become tricky to manage and a volatile political problem. The economy is slowing. And there is growing civil unrest in the far western regions of China that is a major challenge in the eyes of Communist Party leaders.
So, while China won’t be abandoning Treasury bonds anytime soon, the past week’s spectacle in Washington and Friday’s unprecedented downgrading of the U.S.’ AAA credit rating are likely to intensify the feeling among some Chinese that the country should reduce its current dependence on the U.S. and go its own way more often.
That won’t be a plus for the U.S., no matter what happens in the markets.