Out of Control Policy Blog

China Worried Over the Value of the Dollar (with Good Reason)

It seems that Americans are not the only ones worried about the massive debt the United States is racking up and the money that is being printed to pay for the country's stimulus spending binge.  Now the Chinese are worried as well.  A Reuters article reports:

Zhou Xiaochuan, governor of the People's Bank of China, in a series of papers intended for an international audience proposed adopting Special Drawing Rights issued by the International Monetary Fund as a dominant reserve currency.

Though he avoided mentioning the U.S. dollar, the proposal implicitly sought to end its dominance as trade and reserve currency, which Zhou said has contributed to global financial instability.

Why, you may ask, might China want to move away from its investment in the dollar (via U.S. Treasury bond purchases)?  China holds the world's largest reserves, estimated at $2 trillion, the bulk of which is in U.S. Treasuries.  This makes China the United States' largest foreign creditor.  China knows that if the U.S.'s debt gets too high, it might try to deal with that debt by printing more and more money.  The resulting inflation would mean that the dollars the U.S. would pay as interest on those T-bills to the Chinese and other creditors would be worth less and less.

While the size of China's existing Treasury holdings makes it unlikely that China would abandon its dollar-denominated investments, it may still be able to use its power as a large creditor (i.e., through the threat to stop financing the U.S.'s debt through future Treasury purchases, or to purchase less in Treasuries than it otherwise would) to extract some concessions from Washington.  According to the Reuters article,

The world's third-largest economy may ask Washington to lower trade and investment barriers or for the U.S. Treasury to issue callable securities, said [Zhong Wei, professor with Beijing Normal University and editor of China Foreign Exchange, a journal of China's State Administration of Foreign Exchange.]

"China has been buying U.S. Treasuries without asking any questions. Now China is going to put its own conditions."

A similar AP article from earlier this month also noted the nervousness of the Chinese over the value of the dollar.  At a news conference, Chinese Premier Wen Jiabao said,

"Of course we are concerned about the safety of our assets.  To be honest, I'm a little bit worried. . . .  I would like to call on the United States to honor its words, stay a credible nation and ensure the safety of Chinese assets."

By dispensing with its borrow-and-spend, easy-money policies, the U.S. would be ensuring the safety of American assets as well.  How sad it is that we have come to the point where the U.S. must be lectured about fiscal responsibility by China.  This is the kind of advice that the U.S. used to give to third-world countries.  If we do not turn back from the path we have embarked upon and return to a sense of fiscal sanity and responsibility, soon it is us that will be the third-world nation.

Adam Summers is Senior Policy Analyst


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Comments to "China Worried Over the Value of the Dollar (with Good Reason)":

paula | March 31, 2009, 10:45pm | #

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