Hawks in Washington like to warn about China’s military buildup. They should be encouraged by Beijing’s emerging financial drawdown.
China trimmed its mammoth US dollar holdings by US$13.6 billion in October from the previous month, putting its hoard at a 20-month low. This appears to reflect an economic decision to reduce its stash of Treasuries, which at US$1.25 trillion remains the largest in the world.
As China works to expand use of the yuan worldwide, it is moving toward a market-determined exchange rate. That means buying fewer US dollars. Whatever the reason, the decline means that US ally Japan — the second-largest holder of Treasuries at US$1.22 trillion — will soon surpass China again, as it did very briefly last year.
Since 2008, when China took over the No. 1 spot, US officials have fretted about Beijing’s leverage over the US economy. In 2009, then-US secretary of state Hillary Rodham Clinton asked former Australian prime minister Kevin Rudd: “How do you deal toughly with your banker?”
On her first trip to China as a Cabinet member in February 2009, Clinton dropped human-rights issues in favor of prodding China to buy more debt.
“We are truly going to rise or fall together,” Clinton said. “By continuing to support American Treasury instruments, the Chinese are recognizing” that interconnection.
The bizarre spectacle of the US’ top diplomat jingling the beggar’s cup in front of a rising rival enraged conservatives — and rightfully so. The dangers of over-dependence on China are obvious. Chinese leaders have occasionally suggested using Treasuries to pressure Washington on policies they dislike. In August 2011, the state-run People’s Daily ran an editorial saying: “Now is the time for China to use its ‘financial weapon’ to teach the US a lesson” regarding its support for Taiwan.
Influential economists like Brad Setser, a US Department of the Treasury staffer, have long argued China’s bond holdings pose a national security threat. While dumping its holdings would cost China dearly, a selloff could hurt Washington more. As central banks and investors around the world piled on, yields would surge, credit-rating companies would pounce and the US could be pushed into recession — or worse.
Japan’s dollar holdings have been rising to drive down the yen, a cornerstone of Abenomics. Given the trouble Japanese Prime Minister Shinzo Abe is having defeating deflation and prodding companies to boost wages, the yen is sure to go much lower still. Many see the currency reaching ¥150 to the dollar, compared to ¥118 recently, which would mean huge dollar purchases next year. That would easily return Tokyo to a familiar position as the biggest Treasuries holder, which it was for decades before 2008.
Of course, no matter who holds the No. 1 slot, the US’ huge bond exports will always leave it vulnerable. Bond traders remember all too well Japan’s own threats to exploit its dollar holdings.
In June 1997, then-Japanese prime minister Ryutaro Hashimoto said that “several times in the past, we have been tempted to sell large lots of US Treasuries.”
One such temptation came amid contentious auto-industry negotiations.
Still, the bond hoarder you know is arguably better than the one you do not. If Japan were the US’ banker, it would remove a major risk factor in markets. The country is a solid US ally, with a free economy and a government subject to democratic checks and balances. As China’s military ambitions rise, territorial disputes come to the fore and North Korea’s nuclear ambitions grow, Tokyo will have little reason to alienate Washington.
US President Barack Obama can not force Japan’s demand for Treasuries, of course. However, perhaps the US can offer trade concessions as part of Trans-Pacific Partnership talks as an incentive. The US could also give Japan exclusive and direct access to buying debt through the Treasury.
In 2012, Washington let China bypass Wall Street in the first-ever direct buying scheme for a foreign power. Why not shift the perk to Tokyo, as long as Japan agrees to ramp up bond buying substantially?
Likewise, Japan’s stimulus efforts will mean even more debt issuance. Washington could agree to become a sizable buyer of Japanese government bonds (just as Japan is running out of people, it will have fewer willing bond buyers). Tighter financial linkages would encourage each side not to undermine the other.
It is always possible that China will remain a big buyer of Treasuries, but the size and duration of China’s recent drawdown suggests this “is more of a structural trend that’s developing,” Stanley Sun of Nomura Securities told Bloomberg News.
Washington would be wise to encourage the shift to a friendlier banker.
William Pesek is a commentator for Bloomberg.
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