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The lender’s lament

8 October 2013 By John Foley

For China, the U.S. debt ceiling is what Mao Zedong might have called a paper tiger: terrible to behold, but in reality not so scary. Provided Washington doesn’t actually default on Oct. 17, when the Treasury has warned it could run out of cash unless allowed to borrow more, Chinese concern looks needless, and even self-serving.

It’s understandable that the biggest holder of U.S. debt is frustrated. China has a known $1.5 trillion of Treasury and U.S. agency debt. Vice finance minister Zhu Guangyao fretted publicly about the safety of the country’s investments on Oct. 7. Even if the worst case – non-payment – is averted, a protracted standstill over the debt limit could cause a sell-off in American paper.

China would feel the effect in several ways. First there would be a financial impact, as the value of its existing bills falls. But it would be muted. China doesn’t transparently adjust its holdings for fluctuations in market prices, and can buy and hold, so what really matters is repayment and not market prices.

The economic consequences might be worse. If rates rise because Washington’s lenders grow less confident, there could be a U.S. recession. China still relies on healthy demand from American buyers of its goods, though its strategy of keeping its currency, the yuan, closely linked to the dollar offers some insulation.

Strategically, Washington’s woes could be Beijing’s gain. Doubts about the dollar’s ability to remain a safe store of wealth could help China push its own currency as an alternative. China has set up $360 billion of currency swaps with trade partners to encourage them to use the yuan for trade. Anything that reduces the relative appeal of the dollar – including public admonitions from Chinese officials – ought to increase the marginal propensity to accept yuan instead.

One day, if China’s currency does become the global lingua franca, it may face problems much like those of the United States today. The “exorbitant privilege” of being able to borrow cheaply from countries eager to accumulate assets in reserve currency brings with it great pressure to run up debts. Perhaps the best way for Beijing to view the U.S. debt ceiling is not as a crisis, but as a cautionary tale.


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