New Haven: The Chinese have long admired America's economic dynamism. But they have lost confidence in America's government and its dysfunctional economic stewardship. That message came through loud and clear in my recent travels to Beijing, Shanghai, Chongqing, and Hong Kong.
Coming so shortly on the heels of the subprime crisis, the debate over the debt ceiling and the budget deficit is the last straw. Senior Chinese officials are appalled at how the United States allows politics to trump financial stability. One high-ranking policymaker noted in mid-July, "This is truly shocking… We understand politics, but your government's continued recklessness is astonishing."
China is no innocent bystander in America's race to the abyss. In the aftermath of the Asian financial crisis of the late 1990's, China amassed some $3.2 trillion (Dh11.74 trillion) in foreign-exchange reserves in order to insulate its system from external shocks.
Fully two-thirds of that total — around $2 trillion — is invested in dollar-based assets, largely US Treasuries and agency securities (ie, Fannie Mae and Freddie Mac). As a result, China surpassed Japan in late 2008 as the largest foreign holder of US financial assets.
Not only did China feel secure in placing such a large bet on the once relatively riskless components of the world's reserve currency, but its exchange-rate policy left it little choice. In order to maintain a tight relationship between the renminbi and the dollar, China had to recycle a disproportionate share of its foreign-exchange reserves into dollar-based assets.
Those days are over. China recognises that it no longer makes sense to stay with its current growth strategy — one that relies heavily on a combination of exports and a massive buffer of dollar-denominated foreign-exchange reserves. Three key developments led the Chinese leadership to this conclusion:
First, the crisis and Great Recession of 2008-2009 were a wake-up call. While Chinese export industries remain highly competitive, there are understandable doubts about the post-crisis state of foreign demand for Chinese products. Long the most powerful driver of Chinese growth, there is now considerable downside to an export-led impetus.
Second, the costs of the insurance premium — the outsize, largely dollar-denominated reservoir of China's foreign-exchange reserves — have been magnified by political risk.
In recent years, Chinese Premier Wen Jiabao and President Hu Jintao have repeatedly expressed concerns about US fiscal policy and the safe-haven status of Treasuries.
Like most Americans, China's leaders believe that the US will ultimately dodge the bullet of an outright default. But that's not the point. There is now great scepticism as to the substance of any "fix".
All of this spells lasting damage to the credibility of Washington's commitment to the "full faith and credit" of the US government. And that raises serious questions about the wisdom of China's massive investments in dollar-denominated assets.
Finally, China's leadership is mindful of the risks implied by its own macroeconomic imbalances — and of the role that its export-led growth and dollar-based foreign-exchange accumulation plays in perpetuating those imbalances. Moreover, the Chinese understand the political pressure that a growth-starved developed world is putting on its tight management of the renminbi's exchange rate relative to the dollar — pressure that is strikingly reminiscent of a similar campaign directed at Japan in the mid-1980's.
However, unlike Japan, China will not accede to calls for a sharp one-off revaluation of the renminbi. At the same time, it recognises the need to address these geopolitical tensions. But China will do so by providing stimulus to internal demand.
With these considerations in mind, China has adopted a very transparent response. Its new 12th Five-Year Plan says it all — a pro-consumption shift in China's economic structure that addresses head-on China's unsustainable imbalances.
So China, the largest foreign buyer of US government paper, will soon say, "enough". Yet another vacuous budget deal, in conjunction with weaker-than-expected growth for the US economy for years to come, spells a protracted period of outsize government deficits.
The cavalier response heard from Washington insiders is that the Chinese wouldn't dare spark such an endgame. After all, where else would they place their asset bets? Why would they risk losses in their massive portfolio of dollar-based assets?
China's answers to those questions are clear: it is no longer willing to risk financial and economic stability on the basis of Washington's hollow promises and tarnished economic stewardship. The Chinese are finally saying no. Read their lips.
— Project Syndicate, 2011
Stephen S. Roach, a member of the faculty at Yale University, is Non-Executive Chairman of Morgan Stanley Asia and the author of ‘The Next Asia'.