The U.S. and China might think it prudent to seek some fiscal easing at this point — even if it’s a good idea to bully each other domestically.
A tough August for both the Chinese economy, real estate sector and stock market on the one hand, and US government debt on the other, served as a reminder of how fragile the financial and economic relationship between the two sides can be.
For all the talk of decoupling or “de-risking” in Washington jargon, the world’s two largest economies are still intertwined — even if political exigencies demand it, and destabilizing each other is dangerous.
That interdependence — or the desire for it — is far less present in the post-pandemic, post-Ukraine invasion world than it was 15-20 years ago, when China rapidly integrated into the global economy.
Bilateral investment restrictions, trade restrictions and supply chain reversals have fueled espionage and hacking claims this year, as geopolitical tensions over Taiwan and Ukraine escalate and China positions itself as an alternative world leader.
But elements of the once-feared “mutually guaranteed financial destruction” (MAFD) bond still apply. For example, Chinese and Hong Kong companies still hold more than a trillion dollars in US Treasury bills, and the annual trade deficit between the US and China is more than a third of a trillion dollars.
Pulling the rug out from under us — and thus reducing American and Chinese demand — seems to make little economic sense, at least from an economic perspective.
More than a decade later, former U.S. Treasury Secretary Larry Summers modified the nuclear “MAD” doctrine to add an “F” to reflect the cooperative trade and financial ties that had developed between the two emerging superpowers.
A web of US import demand and investment flows connecting them that fueled China’s rapid growth and dollar surpluses, Beijing then largely recycled through the bank the dollars it had accumulated as US Treasury debt. In turn, official intervention and the supply of dollars caused the yuan to appreciate too quickly and make the exchange rate uncompetitive.
Everyone benefited. America gained new markets and investment and a seemingly stable new creditor, which kept credit rates low and consumption high. China received cash injections, export-led growth, foreign know-how and a liquid home for savings.
Summers argued at the time that while nuclear MAD was sustainable, the rising US national debt increased Washington’s vulnerability in a world of “financially assured destruction.”
He argued in a 2009 speech that “there is no reason why foreign governments and investors who finance the spending of the great powers should bankrupt the American economy by suddenly dumping their dollar reserves.” They are also severely damaging their own economies.”
“But now that America has finally abandoned the Cold War military balance of terror, if it can be avoided, a new version of mutually assured destruction should not be accepted lightly.”
But does the post-pandemic situation end there?
A mutual distrust of global influence and economic dominance has been evident over the past 10 years – domestic priorities have been revised from concerns over fair trade, geopolitics around Ukraine and Taiwan, and the shock of COVID-19.
With next year’s U.S. election in mind, the anti-China trade stance has bipartisan support among voters.
Jim O’Neill, a former Goldman Sachs global economist and British government minister who coined the BRIC acronym 20 years ago to track the rise of the largest emerging economies, thinks “a break in the US-US relationship would be truly catastrophic”. China will derail dramatically.
But O’Neill said both sides have decided to get to the bottom of the issues, and China’s continued rhetoric may be a sign.
US Commerce Secretary Gina Raimondo’s decision to accept an invitation to visit Beijing next week shows that the two sides are unwilling to completely sever ties. China’s Ministry of Commerce welcomed the lifting of US export restrictions on 27 other companies “in line with the common interests of both sides”.
Stephen Jenn, hedge fund manager at Eurizon SLJ, thinks the idea of a full cutoff is problematic and requires “calibration” – issues related to high technology and privacy concerns may be a red line, but China will continue to produce goods to satisfy. U.S. demand and holding of U.S. debt.
“The symbiotic relationship between the US and China is very important for the US to consume more and China to have a saving surplus,” he said. “It has to stay that way — otherwise US (interest) rates will rise.”
And this goes to the heart of America’s problem. Summer pointed formally to the rising national debt — which, exacerbated by the pandemic, has more than doubled in the past decade to more than $25 trillion and 20 as a share of annual output. The year has doubled.
Yet China seems to have been regressing for years.
China’s share of outstanding U.S. Treasury bills fell sharply after the country stopped building up dollar reserves over the past 12 years to use its surpluses for its “Belt and Road” trade initiative and government bank deposits.
Although Beijing has partially offset this by investing more in other US dollar bonds and mortgage debt, the share of foreign Treasury bills held by Chinese and Hong Kong companies is below 14%, down from a peak 12 years ago. More than 30%.
As with many bilateral financial relationships, the dependency appears to have been greatly reduced. Any change in the still fragile financial markets will have an equal impact on both sides, and the political signals from here can prove as important as the actual background activity.
The views expressed here are those of the author, a Reuters columnist.
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