The markets have reacted predictability. They have swung
downward ever since the “Tea Party” Republicans and the Democrats played
brinksmanship politics with their collective national debt. The S & P
downgrading signaled more acute response from everyone. People seem to be
running to the safety of gold and silver. Markets as they are usually prone to
do; reacted nervously. None of the reaction was unexpected.
However the collateral damage of the American economy I am referring
to is China. For so many years they have controlled their own currency so that
they remain competitive in their exports. Economies and governments around the
world complained but China paid no head. While the rest of the currency rates
were determined by market factors, China’s governing bodies controlled theirs. One
of the steps China took to keep the value of Yuan appreciating was to buy
billions upon billions of dollars. Who better to buy from then a debtor with long
standing credit worthiness?
As China’s economy continued to grow year after year, they
kept buying Treasury Bills to a point where near about 50% of their reserves
are now in the form of US Treasury Bills. They are the biggest creditors for
the government of United States by a long distance. Second place Japan stands
at $900 billion while China themselves are owed $1.7 trillion. This places them
in such an uncomfortable position. It means that if the dollar erodes then it affects
them proportionately. It means that being such a large creditor there is no one
else who can take up the Treasury Bills from them. They can’t dump some of it
on the market without causing more panic, spiraling the dollar downwards and
eroding hundreds of billions of China’s reserves. They can’t dump it all
without catastrophic results for themselves and the U.S. For better or for
worse their fate is intricately tied with the fate of the U.S; at least in the
short term. So much so that in order to protect the dollar from misadventures,
they will in all probability continue to buy more debt from the Americans. This
in turn will continue to allow the American lifestyle of borrowings and low
interest rates in an attempt to inject life in a slumbering economy.
This leads to a delicious irony. China and the United States
are two of the most powerful countries in the world. U.S has long been the sole
super power ever since the demise of USSR. In normal circumstances, you would
expect China to be quietly satisfied with the American problems. Now however
the world’s largest capitalist and the world’s largest communist are
bedfellows.
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