US Congress picks at China's holdings
By Benjamin Shobert
WASHINGTON - The United States-China Congressional Committee focused last week
on a nagging question that refuses to go away: does it matter if China is
America's bank? Or, said differently, what are the implications for American
geopolitics given China's enormous holdings of US Treasurys?
Estimated to total now at around US$1 trillion, Chinese holdings of American
public debt have become an uncomfortable topic of discussion in the capitals of
both countries. Within the Beltway, at its most productive, conversation over
these questions has focused light on America's own fiscal imbalances. At its
least productive, exchanges on the topic of Chinese Treasury holdings have led
some in Washington to believe Beijing now possesses
the ability to limit and leverage America's actions in ways that are untenable.
Beijing is not without its own political worries with respect to this matter.
Domestically, the amount of American debt they hold has forced many in the
Chinese workforce to wonder if this money could not be otherwise directed
inwards, as opposed to supporting another country's standard of living. China's
politicians also, and perhaps understandably so, do not appreciate being
accused of malice when, at least as seen from their perspective, what they are
most guilty of is winning.
But most problematic for Beijing is their fear that, absent meaningful fiscal
reform in Washington, these large dollar-denominated holdings of US Treasuries
are set to lose value, a concern China's policymakers have begun to be much
more vocal about over the last year.
The congressional committee hearings last week drew on a variety of experts,
the majority of whom agreed with the broad consensus that a "balance of
financial terror" - the phrase of Larry Summers, director of the White House's
National Economic Council - remains the appropriate way to describe the current
US-China economic relationship.
As strong as China's economy may now seem, it is a mistake to forget that the
country still remains a highly export-sensitive economy. Consequently, China is
not in a position to dramatically alter the terms of their trade relationship
with the US, which large dumping of US Treasuries would make necessary.
Additionally, as Derek Scissors of the Heritage Foundation testified, much of
their US holdings are the result of them not having anywhere else to deploy
their current account surpluses. Sounding an unforgotten note in today's
Washington, Scissors reminded the panel that some of this phenomenon might have
something to say about the relative strength of the American economy long-term.
Clyde Prestowitz, president of the Economic Strategy Institute in Washington
DC, testified that the United States "would not be able to sustain ourselves in
Iraq or Afghanistan, or ironically enough patrol southeast Asia with the US 7th
Fleet, or rebuild New Orleans without Chinese money". But in a spirit that was
largely shared by most of those who testified, he quickly followed this up and
went on to say, "We and China are in a sort of MAD [mutually assured
destruction] situation, but we shouldn't push that too far."
For some members of this particular congressional panel, whose original purpose
is to delve into potential national security issues inherent in China's rise,
such a measured response may not fully capture the downside risk inherent in
the Chinese holdings of US debt.
Perhaps with this in mind, the oral testimony of Congressman Frank Wolff
(R-Virginia) sounded a much more alarming note about Chinese intentions. Wolff
made note of the "increasingly aggressive position" of various Chinese military
tussles with the US Navy, and noted that when it comes to the international
policies of the two countries, our "interests rarely align". Wolff, a long-time
critic of China's human-rights record, went further to try and convince those
who attempt and draw parallels between Japan's rise in the 1970s and the
Chinese rise over the past 20 years: "... Japan did not have 35 Catholic
bishops in jail ... Japan was not plundering Tibet ... there is no connection,
and we are just disregarding this reality."
Earlier in the day, Prestowitz seemed to have anticipated this line of thinking
and admitted that the relationship with China has always been troubling in one
particular way: "How closely integrated do you want to be economically with a
country which has very different political values than our own?" However, on
the whole, while last week's testimony never glossed over the potential
long-term effects of China holding such vast quantities of US debt, the
majority of witnesses testified they believed it would continue to be in
China's interest to work with the US.
Throughout last Thursday's testimony, it was noted by most who testified that
China's attitude has noticeably changed over the past several months. Daniel
Drezner, professor of international politics at Tufts University, suggested
that this change in attitude may be the result of two factors. First, China has
been able to keep its gross domestic product growth above 8% (widely seen as
the level necessary to absorb new workers and avoid social unrest), while
other, more developed, economies have struggled to avoid major recessions. This
has inevitably given Beijing's political leaders a bit of swagger, some of
which may explain their attitudes recently.
However, Drezner was careful to give equal time to the possibility that the
events of the past several months may also reflect the desire by politicians in
Beijing to use bluster to cover internal instability. As he mentioned, riots
last year caught China's leadership off-guard. They are not going to miss an
opportunity to tout their economic achievements given the ever-present
possibility of political turmoil. On the whole, most panelists agreed that
China has overplayed its hand in the short-term, and is likely to have to adopt
a more conciliatory tone throughout the balance of 2010 in order to avoid
further stoking unnecessary political fires.
The much bigger issue remains China's currency policy, and in a turn that may
have surprised those watching last Thursday's hearing, a large portion of the
conversation revolved around how best to address this outstanding grievance.
Vice chairwoman Carolyn Bartholomew questioned how the US could best deal with
China's ongoing currency manipulation when she asked: "Why has the US not done
something? [Is it] because China is much better at pulling levers and using
threats?"
In response, Prestowitz suggested that the currency issue continues to play
second fiddle to what US policymakers believe are much more important
questions, matters like North Korea and global warming. But he went further and
suggested that an often overlooked part of why US politicians are reluctant to
advocate for a more aggressive position towards China regarding its currency
policy is because much of what comes out of China as exports to North America
is the result of manufacturing facilities owned by US companies. This business
lobby has its own agenda; as he put it, " ... many of them like a strong US
dollar."
Later on in the day, Leo Hindery Jr, managing partner at InterMedia Partners
VII LP, made this point more explicitly when he said, "We as a nation are
tolerating very selfish trade policies because it is in the interest of
multinationals that have undue influence on the US Congress ... some companies
are going to have to get hurt to help Americans."
The ongoing spat over China's currency is likely to result in two short-term
events that will receive a good bit of media fawning, but translate to very
little in the way of meaningful policy changes. First, it looks probable that
the US Commerce Department is going to formally label China a "currency
manipulator" in a report due out in the next two weeks. While a small change
and, as one panelist noted, "confirming what everyone already knows", this does
allow a nuanced shift in the rhetoric of the debate.
More importantly, such a formal reclassification opens the door for the US to
argue with the International Monetary Fund (IMF) that China is guilty of
currency exchange violations. The second short-term event that most believe
will happen is Beijing announcing in the coming weeks that it intends to make
what Simon Johnson from Massachusetts Institute of Technology last week called
a "small but insignificant" change in the yuan, what he believes will amount to
a classic move on the part of China to defray criticism, but of no meaningful
long-term impact.
Absent more substantive changes on China's part, the US does appear to be
moving towards a more formal dispute with China over the yuan. As several
experts testified last week, most notably Scissors from the Heritage
Foundation, in their opinion a formal dispute is unlikely to drive the sort of
trade re-balancing the US needs. Should the US elect to pursue their grievance
with the IMF, it is unlikely they would get anywhere.
Panelists provided four reasons for why the IMF is unlikely to have any
meaningful influence over China's currency policy: the IMF is still perceived
by many in Asia as an ineffective institution as a consequence of the IMF's
inability to prevent contagion in Southeast Asia during the 1997-98 financial
crisis. Asian countries, and in particular those that are emerging economies,
dislike the overwhelming number of governing seats at the IMF that are
allocated to developed economies. The IMF's credibility has been further
damaged as a result of its inability to catch the US' own more recent economic
catastrophe; and lastly, the IMF does not talk directly to heads of state,
making state-to-state dispute resolution an awkward and ultimately ineffectual
outcome versus more direct talks in the Group of 20 framework or within the
World Trade Organization (WTO).
Most importantly, any dispute resolution mechanism that is likely to be an
outcome of a WTO case over China's currency manipulation will take several
years to resolve, a timeframe few in Washington ever work within, and almost
no-one has in mind today given the current state of affairs.
Based on the stance from most of the expert testimony to the committee last
week, commissioners wanted to know what sort of unilateral options the US had
at its disposal to deal with the yuan under-valuation. It can be drawn from
comments during the hearing that the commission is wrestling with whether to
submit to congress a formal recommendation that the Treasury Department appoint
a high profile expert, someone such as former Federal Reserve chairman Paul
Volker - whose name was specifically mentioned in testimony - to lead
negotiations with China over the question of its currency manipulation.
Several panelists brought up the idea of bringing other countries to the table
in this conversation, namely other Asian economies that have also been hurt by
China's artificially low exchange rate, as well as India.
Against the backdrop of last week's conversation was the nagging question of
whether China is really to blame for its holding of US Treasuries. After all,
as Dr Johnson pointed out, "if it wasn't them, it would be someone else".
Whatever American debt China holds is, after all, debt America elected to sell;
and, absent meaningful fiscal reform in the US, the least of our problems is
likely to be China's long-position on US Treasuries.
Towards the end of last week's hearing, Eswar Prasad, senior fellow at the
Brookings Institution and Cornell University professor of trade policy,
reminded everyone "how vulnerable the US is making itself as a result of our
debt levels". As with many current disputes between the US and China, the
amount of debt China holds may have little to say about Beijing's motives, and
everything to say about the lack of political will power coming from
Washington.
Benjamin A Shobert is the managing director of Teleos Inc (www.teleos-inc.com),
a consulting firm dedicated to helping Asian businesses bring innovative
technologies into the North American market.
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