As the tiger awakens: Mohsin Hafeez on Chinese Power over and Stakes in the US Economy

TOO much of a good thing is bad. So is the case with the kind of democracy espoused by the political structure in America these days. The recent debt ceiling debate in the power corridors of Capitol Hill smacked of the worst kind of politics one has witnessed in the history of the developed world.

The Tea Party thought it fit to bring the country to the brink of the most disastrous scenario that was averted at the eleventh hour. The looming threat of the largest economy failing to keep its obligations was just as unfathomable to us here as it was spooky to the rest of the world. Notwithstanding the deal, and more because of the process that preceded the ‘signed, sealed and delivered’ moment, the debt rating of the US was lowered a notch to AA+ from its premium AAA rating.

In the last over 50 years, the debt limit has been raised at an average frequency of one and a half times every year, without as much as an eyelid being batted. Why it had to unravel the worst form of political showdown in the process this time is beyond comprehension and it does not hold up the high values of the greatest nation on earth, of American exceptionalism.

The US has borrowed with reckless abandon over the last several years.

The bubble finally burst in 2007, bringing with it the Great Recession. Even the brightest minds in the country missed the depth of the issue. Those who got it were snubbed, being labelled as ‘Keynesian’ as if it were a dirty word not fit for public utterance. The stimulus during the first few months of the Obama administration was cut down to size, with the result that it became only a half-baked effort. The Federal Reserve kept lowering the interest rates, and then deployed the silver bullet in the way of buying in billions, a combination of mortgage-backed and other US treasuries, to keep the interest rates from rising.

China is the largest creditor of the US, with about $1.3tr in US treasuries and agency securities. The Chinese found the US to be a safe haven, and holding US treasuries in large amounts also helped them mai ntain a tight relationship between the yuan and the US dollar. With the economic structure of China moving towards consumption, partially to cater to the rising middle class, at the expense of savings,
that strategy has been relegated in terms of importance.

The last few years might possibly have stirred the sagacious, long-term thinking of the Chinese who are renowned for thinking in centuries as opposed to the developed world that, perhaps, might go as far as decades. The global Great Recession has planted the seeds of scepticism in the minds of Chinese policymakers regarding the level of demand of their products.

With the infrastructural boom in the country, while the class struggle still remains an almost insurmountable challenge for some, there is an emerging middle class as the population moves to the cosmopolitan suburbia. That is where they see growth opportunities more than in being able to generate finished products for the developed world. With less emphasis on manufacturing and more on research and development, China now spends an increasingly higher amount in that domain, currently ranked just below the US. Such is the characteristic of the international product life cycle.

Another factor that has swayed their thinking is the increasing cost of the insurance premium related to the Chinese foreign exchange reserves, all the more aggravated now that the US Congress has so ably facilitated the S&P downgrade of their once riskless assets: the US treasuries. The deficit, which has ballooned in the last decade due to myopic world strategies, now constitutes an unacceptable proportion of the US GDP. Cutting it sharply, as the Tea Party demands, only exacerbates current economic woes, especially if it is accompanied with no revenue hikes, which, again, is a non-negotiable with the Tea Party. Unfortunately, the debt ceiling deal negates all that has to do with sensible economics and smacks of political expediency.

The third important factor is the political pressure on China to let the yuan move naturally in the marketplace relative to the US dollar. China realises this has to be managed over a period of time and it will wean itself gradually away from US dollar-based assets as it works to stimulate domestic demand. This is quite apparent in the new 12th Five-Year Plan. The plan strives to raise the consumption portion of China’s economy quite precipitously. The corollary of the above clearly indicates a mopping up of the external saving account, or, at least, rationalising US dollar reserves.

With the above scenario in place, it behoves US policymakers to not pooh-pooh the innate, subtle power of their largest creditor China. Contrary to the popularly ingrained belief that it will not dare go any place else, the sleeping tiger does have options. The option need not be to deplete US-based reserves; just some scaling down can have undesirable effects on the US markets, and thus the world. It is also time the US Congress and political leaders start playing the adult in the room and in a manner more consistent with that of a First World chamber.

The writer works for an international financial services firm in the US. mohsinhafeez@yahoo.com