As state-run Chinese media outlets continue to blast the U.S. government for the profligacy that led to last week’s credit downgrade, Chinese citizens have begun to weigh in as well. Online, many comments reflect the line of the state press, that the U.S. penchant for irresponsible borrowing and spending led the world’s sole superpower into this mess, and threatens to drag the rest of the world along with it. But that sentiment is tinged with criticism, unheard in the domestic press coverage, that the Chinese government bears responsibility for placing so much faith and foreign reserves in the hands of the U.S.
China’s role as the largest foreign creditor of the U.S.—it owns at least $1.16 trillion in Treasuries—has prompted concern here that China will pay for such a heavy reliance on the world’s biggest economy. “It was a huge mistake to buy U.S. bonds with Chinese taxpayers’ money. We must hold those who are involved responsible,” wrote one commenter on a Chinese-language message board. “From today onward, we should say that to continue to buy American debt would be China’s own mistake,” another person wrote on Sina Weibo, a leading Chinese microblog.
Sun Lijian, a professor of finance at Fudan University in Shanghai, explained China’s dilemma this way: “Essentially, the downgrade will lead to a sharp drop in long-term bond prices, and adjustments in bond yields will cause the market to favor higher liquidity. In a word, it’s a very disadvantageous situation for China.” And it’s a situation that the Chinese government can’t readily walk away from, either. A sell-off of Treasuries would hurt their value, leading to losses for the Chinese on their investment. And to the extent that a sell-off would harm the U.S. economy, it would inflect considerable harm on China’s export sector as well.
That reality undercuts any domestic criticism of China’s lending to the U.S. My colleague Bill Powell today cites Peking University finance professor Michael Pettis’ explanation that such purchases of U.S. debt are not simply investments, but also trade policy. China borrows on the domestic market to buy U.S. debt in order to keep the value of the Chinese currency from climbing. Keeping the value of the renminbi low boosts the competitiveness of China’s exports, a key component of the country’s economic growth. Without such purchases the value of the renminbi would climb faster than China would like, which would have serious repercussions for export-focused Chinese manufacturers. Until domestic consumption plays a more dominant role in driving China’s economy, the government will remain bound to overseas lending, regardless of what angry citizens may say.
Economic conditions leave the Beijing government confined in other ways, too. Inflation hit a three-year high last month, the government announced Tuesday. While many economists suggest that will mark a peak, and inflation should begin to ease, it will stay uncomfortably high for Chinese consumers. With the prospect of another recession in the U.S. looming, China’s central government will want to stimulate growth at home. But an overly loose monetary policy could see inflation come roaring back. “This is a dangerous game,” IHS Global Insight analysts Xianfang Ren and Alistair Thornton wrote Tuesday. “Despite the softening influence of lower commodity prices, inflation will remain higher than target, narrowing the policy space for an easing of monetary policy. Indeed, the government will find itself cracking open the credit gates at a time of higher structural inflation. This increases the risk of a rapid inflationary take-off, just at the same time as the risk of a US-led hard-landing is increasing. The government is steering into a monetary policy bind.”
–with reporting by Jessie Jiang