Rebalancing Sino-US Ties

Until the arrangement went off the rails last summer, the global economy was pulled by two engines: one producing and saving and the other consuming and speculating. China manufactured its export on full throttle and lent its massive savings to fuel America’s consumption binge. Buoyed by low-interest credit from China and the world, Wall Street built ever higher castles in the air, including unintelligibly risky mortgage-related securities. Now that the castle has fallen, the Chinese engine has stalled. Re-igniting these engines is not just the worry of Washington and Beijing, but of the whole world. Talk of ‘decoupling’ Asia has given way to the new buzzword: global rebalancing.

The relation that needs rebalancing the most is also the hardest. Although China’s exports have dropped 18 per cent year-on-year, it is still sitting atop a mountain of trade surplus and its reserves stand at a record $2 trillion. Nearly half of that reserve is believed to be invested in US Treasury bonds and other dollar-denominated assets. Over the years, Chinese purchases of US treasuries helped keep US mortgages low and acted as a vendor’s credit. American consumers borrowed heavily to acquire houses and turned these collaterals into virtual ATMs to borrow cash and buy giant television sets and SUVs.

With export orders drying up and near-zero earnings from treasuries, can China continue as before? As Barack Obama’s massive stimulus package pushes the budget deficit to over $2 trillion in 2009, America’s need for China’s investment is greater than ever. But the stimulus bill’s ‘buy American’ provision and Washington’s anti-dumping complaint against China threaten to hurt the very export that allowed China to be the top lender. With rising debt and the risk of the dollar falling, China is increasingly wary of putting all its investment eggs in the dollar basket.

Not surprisingly, US Secretary of State Hillary Clinton used her maiden trip to urge China to keep buying US Treasury bonds. A skittish world waits to see if China will oblige. The global economic interdependence is now just too deep to fail. And despite a sharp drop in demand, the US market remains China’s biggest customer.

Despite the economic turmoil the dollar remains the world’s reserve currency, and China finds itself in the position of a banker whose outsized customer’s loan default becomes the bank’s problem. If China is seen as beginning to liquidate its treasury holdings, the resulting stampede away from the dollar will be ruinous for China. On the other hand, as the biggest creditor, China’s economic clout can be turned to other advantages. It was no coincidence that Clinton, remembered for her tough words on China’s human rights records, said she would not allow differences on human rights to interfere with Sino-US cooperation. As Clinton put it, “By continuing to support American Treasury instruments, the Chinese are recognising our interconnection. We are truly going to rise or fall together.” With its new clout, China might pry open the door to US high-technology and dual-use items that have been denied to it in the past.

While China might have to continue to be America’s reluctant creditor, the other job it is being asked to perform — slow down its export engine and ramp up domestic growth — will not be easy. Falling exports have already led to thousands of factory closures, sending some 20 million workers back to their villages. The Chinese government has adopted a massive $586-billion stimulus package, directed mostly at infrastructure projects. How many jobs they will create remains to be seen. The government attempt to keep factories humming by creating demand for appliances and household items through subsidy and cash handouts has had limited success because unemployed workers tend to hold on to their wallets for fear of worse times to come. In the absence of a social safety net and health insurance, saving has always prevailed over spending; it is more so now than ever. To address this core obstacle to balancing the economy the Chinese stimulus package also includes an 850 billion yuan ($124 billion), three-year plan to spread health insurance to 90 per cent of the population.

The impact of the stimulus may kick in slowly and China’s growth rate this year may fall below the 7 per cent target, but the rebalancing of the economy being forced upon China by the crisis may prove to be a blessing in disguise.