The Crisis Might Aggravate China—U.S. Imbalance

The thought of a stable market and economy by the U.S. government, is to support corporations and individuals to de-leverage with its high rate of leverage, while China continues to finance the U.S. fiscal deficit.

By reporter Wang Jing from Caijing Online

The imbalance of the global economy is regarded as one of the main reasons for the spread of the current economic crisis. Judging from the actions by the Chinese and U.S. governments, at least in the short term, the imbalance between China and the U.S. might become greater.

On Dec. 8, in Caijing’s Macroview Weekly, issue 16, Sheng Minggao, Caijing’s chief economist took apart U.S. policies aiming to stabilize its economy. He judged that the imbalance between China and America will inevitably increase if China continues to finance the U.S. government.

Starting from the key factors of the subprime crisis and its consequences, Sheng analyzed the effects that the actions of the U.S government for a stable market and economy will have.

He thought that the subprime crisis and its consequences resulted from many factors converging at once, among them, high rate of leverage is the key factor to make and quickly aggravate the crisis.

Many financial institutions and investors must de-leverage to save themselves from the financial crisis and this tide of de-leverage further pulls the crisis into an abyss.

The U.S government is the only body able to finance for markets before the markets get confidence back. The introduction of the $700 billion bail-out program, or other bail-out funds the U.S. Treasury Department has paid or committed to pay, or the expected $500 billion bail-out plan by the incoming Obama government that is amid discussion now, are actually government-aided financing to help some financial institutions and corporations lacking credit and financing ability. Or in other words, the government is increasing its own leverage to help the private sector to de-leverage.

Who is going to finance the U.S government? Very likely, China’s increasing foreign exchange reserve will be used to acquire American Treasury debt. By this September, China has taken the place of Japan as the US government’s no. 1 creditor, totally holding $585 billion of the U.S. treasury bonds. Within 12 months before this, China acquired $117.3 billion of the treasury bonds, 11.5 percent of the U.S government’s newly issued treasury bonds and 18.8 percent of the total treasury bonds acquired by overseas investors at the same time.

As long as Chinese foreign exchange reverse continues to grow, no way to shun the acquirement as the U.S. treasury bonds is still a “safer” investment than others. The amount of U.S. treasury bonds acquired by China increased monthly from July to September, the September increment even larger than the growth of the reserve, are evidences that Chinese government is possibly restructuring its foreign exchange reserve.

Now the pattern is, the leverage of the U.S. economy may lower a bit, but the U.S. government’s deficit will boost a lot, and China will continue to finance the deficit. Judging from this, in the crisis, the imbalance between China and America shows no trend of improving but a trend of worsening. China, as the bearer of the U.S. treasury bonds, will have to bear the risks of dollar devaluation and liquidity trouble of the treasury bonds, if the Federal Reserve runs its money printing machine on all cylinders.

Meanwhile, to stabilize Chinese economy, the Chinese government has revoked the policies used to correct the trade imbalance, including a full rise in the tax rebate rates for export goods, large-scale interest-rate cuts, investment growth and the possible RMB depreciation. While the revocation might help ease pressure on Chinese exporters for a short term, it could result in a situation in which the already big trade surplus and foreign exchange reserve keep going up, then further the imbalance between China and outside economies.

If the U.S economy touches bottom and gets revived soon, its future demand growth will give a strong hand to China’s exporters and Chinese export-oriented economy might go to a turning point. Otherwise, a big test will lay ahead in the way China pursues a stable economic growth, if it turns out to be the U.S. economy will take three years or more to come alive, while China has a weak external demand in one hand, and sagged domestic consumption in another. More importantly, the Chinese government will lose its dominance in tackling the crisis, especially the national structural reform, and China’s future growth will turn more vulnerable to external shocks.