Chinese Premier Wen Jiabao’s statement that he was worried about the safety of US T-bills has been widely perceived as yet another move in a delicate power game being played between the two economic superpowers. It was just a few weeks ago that US officials accused China of manipulating its currency and using this to facilitate a mercantilist policy. Mr Wen’s statement could be read, therefore, as saying if-you-want-me-to-revalue-I-won’t-finance-your-deficits. The dependence of the US on China was fully exposed when Hillary Clinton flew to Beijing to ask China to continue buying US T-bills, even as China has set itself the goal of making more of its growth domestically driven, and thereby less export-dependent. What is important is that both countries need time to re-adjust their economies, and it is arguable that China has the easier challenge.
Around two-thirds of China’s huge foreign exchange reserves are invested in US T-bills, whose value has been at risk even though the dollar itself has gained against the major currencies in the last few months. The spreads of credit default swaps (CDS) for US T-bills are seven to eight times what they were a year ago and, the way things are going, they are set to rise even more. The chairman of the US Federal Reserve, Ben Bernanke, estimated earlier this month that the US’ official debt-to-GDP would reach 60 per cent over the next few years, up from 40 per cent before the meltdown happened, thanks to the bailout package and the big financial obligations that the Treasury has had to take on, and will have to take on in the months and possibly years to come. Independent of this, according to estimates put out by the US Congressional Budget Office (CBO) in January, the US fiscal deficit (expected to cross 12 per cent of GDP this year, compared to 3.2 per cent in 2008), could rise to a mind-numbing 22.5 per cent in 2050; and given that the rise in debt is directly correlated to the rise in deficits, the impact is obvious.
The CBO’s bleak projections are on account of the very large commitments on social security spending and medicare/medicaid — spending on these two heads, according to the CBO estimate, would be around 18 per cent of GDP in 2050. That is why reforming the financing of these segments is vital. President Obama has promised to work on it, but how he can do it when the economy is in for a long stretch of difficult times is anyone’s guess.
So far, the reason why China has been willing to invest in low-interest US T-bills is the fact that this financed US imports and thereby helped keep China’s gargantuan export machine working and that, in turn, kept the employment machine humming. In other words, China’s investment in US T-bills was linked to keeping social tensions in China within manageable limits. If one part of the compact isn’t working any more, why honour the other? The short point is that the dollar’s status as the world’s reserve currency is what has allowed the US to sustain what in the long run is an unsustainable economic pattern. There is no immediate challenge to the dollar, and none on the horizon either. But if the US keeps managing its economy in such a manner that the world has to seriously look for an alternative, then an alternative will be born and the US will have lost a principal element of its financial leverage.
