U.S. and China: The Drug Addict and Its Dealer

“If you owe the bank 100 dollars, that’s your problem. If you owe the bank 100 million dollars, that’s the bank’s problem.” If in John Paul Getty’s quote we substitute millions with trillions, we would get a precise summary of the current situation between China and the U.S. Washington always plays the role of the debtor and Beijing takes the role of the bank that, in recent weeks, has realized the gravity of its problem.

The U.S. credit rating downgrade and the debt drama on both sides of the Atlantic suddenly took the point of view on the financial symbiosis between the first and second economies in the world and turned it upside down. Until very recently, the U.S. worried about being too dependent on its largest creditor, which holds U.S. bonds equal to $1.17 trillion. Now China is starting to get scared and to realize that it is unwise and even dangerous to sit on such vast dollar assets. Despite all the tirades about a new financial order and a new reserve currency to replace the declining U.S. dollar, Beijing does not seem ready to release their yuan and nominate it as a successor.

Switching roles

All this radically changed the tone of the dialogue between the world’s largest power and the newly emerging giant in the East, a switch that became evident during Joe Biden’s visit to Beijing. There were none of Washington’s usual instructional lectures on human rights, Tibet, Taiwan or the underrated Chinese yuan. As Hillary Clinton recently said, “How tough do you get on your banker?” Under the current circumstances, the more logical scenario would be that instead of Biden pressuring China on the yuan issue, China would give the U.S. pressure because of the dollar’s instability.

Indeed, the hosts in Beijing definitely did not play the role of the reproached and indignant student this time. However, they also politely avoided more gloating or destructively critical statements that had been abundant in Chinese media after the U.S. debt ceiling was raised and the credit rating dropped. The peaceful message of Biden’s meetings in Beijing was a sign of a future cooperation based on mutual interests and shared responsibilities.

Your currency is our problem

Despite the formal politeness, the tone in Chinese media and among supporters of government policy is quite different. Last week governmental agency Xinhua published an editorial comment that condemned the U.S. debt dependency and asked for international control over the release of dollars, as well as a new global reserve currency that would help avoid the catastrophe caused by a single country’s fall. Apart from this, the agency also stated that China has the full right to require the U.S. to take steps to resolve its debt problems and to ensure the security of Chinese assets.

The counter reactions in the U.S. were also far from quiet. “I think the Chinese reaction is the height of hypocrisy. Who, after all, is buying more Treasury bills than anybody in the world? Who, after all, is financing the U.S. trade and budget deficits more than anybody in the world — all for their own selfish purposes? China, remember, buys $2 billion every day in the currency market to keep their exchange rate undervalued to give them a huge, unfair advantage in world trade,” said Fred Bergsten, director of the Peterson Institute for International Economics, in a podcast posted on their website. Indeed, if the U.S. were a drug addict, then China is their dealer and is almost as guilty of furthering the U.S. financial imbalance as the politicians in Washington.

Thus Beijing trapped itself in what the former member of the monetary commission of the People’s Bank of China described in a Financial Times article as a “dollar pitfall.” The Chinese government created the second biggest economy in the world partially by sustaining a cheap yuan that would stimulate exports. In order to accomplish that, they bought large bonds of U.S. securities. Now, any attempt on the part of Beijing to get rid of the accumulated U.S. debt would be suicidal because it would drown the dollar even more and would devalue China’s own vast currency reserves. According to a statement in the L.A. Times from Peter Morici, an economist from the University of Maryland, “China’s (economic) success is a joint product of Chinese action and U.S. inaction. America’s fiscal woes are a product of both countries.”