Saturday, 3 March 2007

Is the US vunerable to large Chinese dollar holdings? Clinton's letter to the FED.

As a possible sign of tensions to come (or more accurately to exacerbate existing tensions) between the US and China comes a letter written by a US presidential candidate for the Democrats to the Secretary of the United States Department of the Treasury (Henry Paulson) and the Chairman Federal Reserve Board (Ben Bernanke).

There is plenty of economics to get our teeth into but lets deal with the anti-China message to begin with. Consider the following quotes from the letter:

Talking about the recent stock market volatility supposedly triggered by the 9% fall in China (but now largely discounted).
But what happened yesterday underscores the exposure of our economy to economic developments in countries like China. As we have been running trade and budget deficits, they have been buying our debt and in essence becoming our banker.

On the ownership of US debt by China and Japan:
I have long argued that a great source of vulnerability is the fact that other countries, including China, own so much of our debt. Today, foreign nations according to the most recent Treasury statistics hold over $2.2 trillion or 44% of all publicly held United States (U.S.) debt with Japan and China alone holding nearly $1 trillion. In essence, 16% of our entire economy is being loaned to us by the Central Banks of other nations. Having so much debt owned by other countries can be economically unsound. Yesterday it was the sell off of foreign stocks that had reverberations in U.S. markets. But if China or Japan made a decision to decrease their massive holdings of U.S. dollars, there could be a currency crisis and the U.S. would have to raise interest rates and invite conditions for a recession.

There is a real economic debate underlying this quote. Chinese saving ratios are amazingly high, US saving rates are astonishing low. Then there is the (possibly) overvalued RMB exchange rate. This is however, not all there is to it.

The question is what will happen in the "long run"? If Hilary gets into power how would she address this issue (as it will not go away any time soon). The prospect of the Chinese and Japanese governments selling dollars would cause the dollar to weaken considerably. The reasons why China and Japan hold so many dollars and US paper needs to be looked at carefully. All may not be what it seems.

What incentive do these governments have in seeing a weaker dollar? That would not help their exports which provide large numbers of domestic jobs. If anything China will continue to buy dollars to maintain the artifically low exchange rate (hence why the US wants China to revalue its currency).

Suffice to say, this is a complex issue and this oversimplified letter will not necessarily help matters. At worst ......

The full text can be found here.

Senator Clinton Calls for Action to Address Economic Vulnerability Created by Growing Foreign-Held Debt

Hat-tip: Greg Mankiw's blog (not a Democrat.......)


ChinaRedux said...

Great post. Indeed, there seems to be serious intellectual (i.e. not political) disagreement among the world's top economists on this issue.
Furthermore, the argument over the danger posed by rapidly increasing US debt holdings by foreign countries is of a piece with the larger argument still raging among economists: do deficits (especially budget deficits) matter for the US economy? The administration has said no to the latter (rather emphatically). Former Treasury Secretary Robert Rubin and his long list of followers (including new CBO director Peter Orczag and Sen. Clinto herself) disagree vehemently.
The closest thing to reasonable consensus that I have found is that most economists believe deficits and debt holdings do matter, but how much depends on the size and nature of each.

Jack Dee said...

Sen Clinton writes

I believe that the economic policies of the last six years have contributed to an erosion of U.S. economic sovereignty and have made us more dependent on the economic decisions of other nations.

Economic or political power being linked, This 'Erosion of U.S. economic sovereignty' is exactly what the global economic system needs.
A simple utilitarian calculation will easily show that lifting 100s of Millions of people out of poverty in the developing world is more important than keeping 10’s of millions in affluence in America.
If the U.S. does become more dependent on the economic decision of others that is to be applauded and encouraged.
The global market place and information systems are now in place, but the political systems are still far behind.
This fear of Sen. Clinton. is self centered perspective of a beltway insider.Neither Washington nor New York should be the center of the world. Such a view is both undemocratic and irrational. How can America maintain a position of moral leadership in the international community if her own leaders are actively seeking to deny other nations the same benefits that they have enjoyed in the past ?