China Chokes Off America’s Money Supply

For years, both countries coexisted in a perfect symbiotic relationship. But the United States can no longer count on the People’s Republic to finance its standard of living. America must start helping itself.

They’re still as thick as thieves, China and the United States. So much so that the renowned historian Niall Ferguson coined the neologism “Chimerica” that eventually found its way into the language.

For years, it had been the perfect symbiosis of two economies: China manufactured and exported, America bought and paid, China used the dollars to buy up U.S. government bonds, which kept interest rates low and stoked more consumption.

A perfect cycle that helped America offload low-interest debt that was necessary to provide economic stimulus packages and bailouts for banks. $260 billion flowed into the United States between mid-2008 and 2009. Return address: Beijing.

The total federal, state and municipal debt in the United States currently stands at 75 percent of the Gross Domestic Product (GDP), or over $10 trillion. One-tenth of that is owed to China, which now replaces Japan as America’s largest creditor. The interdependency is shown even more clearly when one looks at China’s total foreign exchange reserves: 68 percent of the $2.45 trillion is invested in U.S. securities of all types.

But the rules of the game have since changed and it’s no longer certain the United States can continue to count on its communist allies. America’s mountain of debt is growing too rapidly and the Chinese are beginning to have too many doubts that the U.S. economy can rebound for it to continue offering America unlimited credit. If the U.S. does suffer a double-dip recession and the dollar loses value, there goes the fortune China has loaned to America. China has in fact already begun redirecting its cash into Japanese government bonds. The International Monetary Fund (IMF) warns that the federal debt ratio could rise from the current 64 percent to 80 percent of GDP by 2015 and has urged the United States government to increase savings.

Domestic Help

But who will play the role of the thrifty saver if China and the oil-rich Gulf states don’t? President Obama has to turn his attention inward to his own nation.

China’s foreign reserves notwithstanding, the traditionally extremely low savings rate of the spendthrift Americans has already risen to 6.4 percent, and America again holds the majority of its own government bonds. Washington has to hope that Americans continue to find that their own bonds have sex appeal. “Foreign demand will not keep pace with the rising debt,” warns the IMF.*

If the IMF prediction is accurate, the danger that U.S. interest rates will sharply rise increases. Obama will find it increasingly difficult to refinance American public debt, consumer demand will decrease and the economy will continue to suffer — a vicious circle that threatens the world’s largest economy. IMF experts reckon that the real interest rate over the medium term will rise 0.6 to 1.5 percentage points while the prime rate remains permanently at 0 percent. Absent that, the United States will find no takers for its treasury bonds.

What is certain, however, is that Obama can no longer unconditionally depend on foreigners. The IMF calculates that non-American investors will be willing to make new investments as long as they do not exceed 3 percent of GDP. Even if American consumers save more and invest more in their own debt, there would still be a demand gap of some 29 percent of GDP. Despite that, the IMF experts are nonetheless optimistic: they are betting that foreigners will begin buying U.S. treasuries at a rate equal to that seen before the onset of the economic crisis. For China, they predict that U.S. bonds held by China will increase by 50 percent to around $1.56 trillion.

That’s a brave prognosis; China’s currency reserves are no longer growing astronomically. In the first 6 months of 2010, they increased by only 2.3 percent — a noticeably lower increase compared to the latter half of 2009. A change with dramatic consequences for a United States that needs new capital like a junkie needs drugs.

The USA is in withdrawal and their supply is drying up because China’s export surpluses are also drying up, say experts like Stefan Schilbe, chief economist at HSBC Trinkaus. Not necessarily because China’s economy is less productive, but because Chinese workers are earning more and the demand for imports is rising. In the face of that, the Chinese central bank and the government in Beijing is doing all it can to dampen the speculative influences coming into the country. “The new currency exchange rate policy will help reduce China’s tendency to acquire ever-increasing foreign reserves,” says Ulrich Leuchtmann, chief currency analyst at Germany’s Commerzbank.

Chimerica’s end is approaching.

*Editor’s Note: This quotation, accurately translated, could not be verified.