There have been quite a lot of articles published in newspapers in recent two months or so, regarding Sino-U.S. economic relations. However, with disparities in position, there are many arguments. When talking about China’s economy, Chinese media and critics often begin with something like, “The U.S. financial crisis is taking its toll on the Chinese economy …,” as if the crisis had pushed China’s economy into a dismal abyss.
Due to a lack of free access to information and professional knowledge people in China are deeply misled by state-controlled propaganda. Contrary to the views from people in China, many overseas observers have come up with very striking viewpoints, including introducing the idea that the U.S. financial crisis is actually a result of “China’s conspiracy.”
In fact, these two viewpoints have ignored the fact that with closer bilateral cooperation in trade and finance, the two economies are deeply interdependent. This is not because the two administrations want close ties or are encouraging some sort of “conspiracy.” In fact, it is because of China’s open door policy over the last three decades that a huge amount of capital has gradually entered China.
The Troika for China's Economic Growth Has Long Broken Down
China’s economic foundation is so weak that there have long been various potential crises both in China’s real economy and its fictitious economy. As a result, the troika for China's economic growth—import and export trade, domestic demand and investment, has shown ominous signs in the past two years or so. In my article entitled “Olympic Dreams Cannot Overshadow China’s Economic Downturn” released in March, I pointed out that 2008 would be the turning point for Chinese economy’ falling from prosperity to depression. However, the U.S. financial crisis has become a scapegoat that the Chinese regime has used to mask its serious industrial policies and economic structure problems. This is the case in recent years, particularly in regards to the U.S. sub-prime mortgage crisis.
In fact, in terms of timing, China's real estate and the stock market crises preceded the U.S. financial crisis. China’ problem is that the Chinese regime continues to transfer crises with the state-owned enterprises and financial industries to the stock market. And speculators have long manipulated the real estate market. In early 2006, about 60 percent of housing buyers were speculators. Due to safety concerns, imports of goods made in China have been gradually prohibited within the U.S., European Union and Japan since 2005. Even if these countries were not affected by the financial crisis, they would not continue to import the toys, footwear and foodstuffs made in China either. There is no problem to say that the Chinese financial industry is not so much affected by the crisis in the U.S. and other countries around the world. However, what has really impacted China is the serious decline in its foreign exchange reserves.
Which Part of China’s Overseas Investments Is Hardest Affected by the Financial Crisis?
Some $1 trillion out of China’s $1.8 trillion foreign exchange reserves has been used to purchase U.S. government bonds and agency bonds. Among them, about $480 billion to $500 billion were invested into U.S. Agency Debt Securities. We don’t know exactly how much China has invested in U.S. bonds Fannie Mae and Freddie Mac, but according to Standard & Poor's, the figure would be around $340 billion. Unfortunately, the value of these bonds has shrunk 90 percent, but the value of the U.S. government bonds has not been unaffected.
Two most commonly asked questions: Why did the Chinese regime purchase so many U.S. bonds? Now that the U.S. has undergone the financial crisis, why did the regime still promise to purchase more U.S. bonds?
The answer is quite simple as follows:
As an investor, the Chinese regime should have taken into consideration how to diminish the risks. When dealing with a huge amount of foreign exchange reserves, any government must clearly know the risks of putting all their eggs in one basket. As early as the time when China’s foreign exchange reserves was about $700 billion, the Chinese competent authorities started to contemplate the diversification of its foreign exchange reserves, so as to diversify the risks; however, it failed. As a result, it had no choice but to put much of its foreign exchange reserves in the “U.S. basket” as usual.
Why was that? The answer is very simple. Other “baskets” were more fragile than the U.S. “basket.” One of the criteria for measuring a country’s asset risks is the ratio of national debt to gross domestic product (GDP). Currently, the ratio of U.S. foreign government national debt to GDP is more than 70 percent, while Japan’s could reach 140 percent. E.U. countries are similar to the U.S. The Maastricht Treaty stipulates that one of the criteria for E.U. countries entering the Euro system is that their national debt should not exceed 60 percent of their GDP, but this provision has not been strictly enforced. For instance, Italy's national debt accounts for 90 percent of its GDP, and the situations for Germany and France might not necessarily be better than that of the U.S. In fact, this financial crisis is the tip of the iceberg for E.U. countries with fictitious economies, showing that these countries’ problems are more serious than that of the U.S. From the perspective of the real economy, E.U. countries appear far inferior to the U.S. Even during the worst period of time in September 2008, the U.S. monthly consumer price index (CPI) remained unchanged. The fall of energy cost, coupled with the slowdown of its economic growth, has quickly compensated for its inflation effect, and American families’ average income is still higher than their expenditures. Even if it is still at the financial crisis stage, the U.S. unemployment rate is far lower than that of European countries during the normal time.
Based on the above considerations, China has invested most of its foreign exchange reserves into U.S. government bonds. During the four weeks prior to October 20, the United States had sold out about $100 billion of its government bonds altogether, and it was believed that China was one of the buyers.
Fear of China Manipulating U.S. through Sovereign Wealth Funds
Since last year there has been a lot of discussion about the Chinese regime possessing too much sovereign-wealth funds. In February 7, 2008, the U.S.-China Economic and Security Review Commission (USCC) held a hearing about being vigilant and deflecting the Chinese regime from investing funds. Several congressmen called on the Bush administration to examine foreign governments’ established investment in U.S. corporations. They showed their concerns of foreign government constructing and operating these kinds of sovereign wealth funds. They worried that the investment, besides economic considerations, may have political and strategic consideration which could affect national security in the U.S. The U.S. Committee of Foreign Investment was accused of being “a guard dog without teeth,” putting economic benefits above national security.
This discussion depends on one's point of view. Due to different economic considerations, the U.S. didn’t alter its position. Concern has led to unnecessary worry about the U.S. stock market as it continues to decline. If China wants to strike the U.S. down, it can just sell all the U.S. national bonds to the market which will make the U.S. economy collapse. A CNN reporter asked Chinese leader Hu Jintao on September 23, “China is the largest owner of U.S. short term national bonds. It is estimated that the value of the bonds is close to $1 trillion. This makes some Americans panic. Can you calm them down and ensure that China won’t take this its status as some form of weapon?” “The weapon with some form” in the question includes the possibility of selling the U.S. national bonds to the market. Premier Wen Jiabao said, “We also hope the U.S. can continue to develop, as it will benefit China. Of course, we are worried about the security of U.S. assets possessed by China. However, we believe the U.S. is a trustworthy country… I believe cooperation right now is the first and foremost.”
The above paragraph, including all the dialogues about Sino-U.S. economic relations were not seen on the media reports in China.
Wen’s speech contains true words from his heart. The fact is that China won’t sell a large number of U.S. national bonds to the market. That is to say that China doesn’t want to commit suicide right now. Think about it: If China sells out a large number of U.S. national bonds to the market, who can have such strong financial power to buy them? If there is large-scale selling but no buyer, it means the selling price will dramatically plunge. Although the Chinese regime is eager to substitute United States to become the world number one, however the time is not right to take this suicidal tact.
In order to avoid loss on its investments, the Chinese regime’s wisest choice is to continue cooperation with the United States. That’s what it did this time. Since the mid October, the U.S. currency has been increasing dramatically and values of U.S. national bonds are increasing as well. Looking holistically, China’s investment in U.S. national debts is a good choice.
The economic relationship between the U.S. and China is becoming closer, and the focus of this economic trade (textiles, toys industry, and clothing industry) has been changed to investment cooperation in financial circles. The “China factor” has been added to U.S. politics more and more. For both countries, this new relationship is neither a hostile relationship nor a strategic partnership. It is tied completely with economic benefits which is more complex than U.S.-Soviet relations during the Cold War.
Reprinted from Open Magazine