Debt default could cause China to rethink its investment in U.S. dollar assets
A U.S. debt default could spur China to diversify its multi-trillion-dollar foreign exchange reserves, the world’s largest, analysts say, as Beijing seeks to boost its voice in the global economy.
A historic default would inevitably lower the value of China’s U.S. dollar assets and have a broader impact on its economy, the second-biggest in the world.
Chinese officials and state media have already sounded the alarm as the deadline approaches for the divided U.S. Congress to raise the debt ceiling and avoid the financial catastrophe.
Analysts said the heightened possibility of default is likely to cause China to further diversify its reserves — which it is already doing — and even trim holdings of U.S. Treasuries, but they ruled out Beijing dumping its holdings.
The bulk of China’s foreign exchange reserves, which reached a whopping $3.66 trillion by the end of last month, are held in the greenback.
“If there really is a default, the Chinese government will definitely speed up foreign exchange reserve diversification, seeking safer bonds of other countries,” said Liao Qun, Hong Kong-based economist for Citic Bank International.
“If there is an acceleration in diversifying, there might also be a reduction in holdings (of US Treasuries),” he told AFP. “China has a reason to do so, but of course it would be extremely difficult.”
China is the largest foreign holder of U.S. Treasury bonds with $1.28 trillion, closely followed by Japan at $1.14 trillion.
Any large-scale selling of U.S. debt by China would erode the value of its remaining holdings, analysts said, while few other asset classes anywhere in the world were large enough to park such vast amounts of cash, leaving Beijing with few practical alternatives.
In the longer term Japan may also rebalance its portfolio a tad to diversify away from holding US government debt, said Yoshikiyo Shimamine, executive chief economist with Dai-ichi Research Institute in Tokyo. However Tokyo’s political dependence on Washington — for example, in its defense pact — mitigates against a sudden switch, he added.
“There is no financial instrument that is as highly liquid as U.S. Treasuries,” he said, implying it is difficult to see any major economy abandoning them.
But China is committed to reducing risk by diversifying its reserves, while at the same time shifting investment away from purely financial products to industrial projects.
However another worry for Beijing is any impact a U.S. debt default would have on the American and global economies.
China is heavily dependent on exports and foreign investment to maintain momentum in its own economy, which expanded 7.7 percent last year, the slowest growth since 1999.
A default “would definitely have a noticeable impact on the U.S. economy”, said Sun Junwei, a Beijing-based economist for British bank HSBC.
“In this way, it would also have a negative impact on China’s economy,” she said.
Chinese officials have used the opportunity to criticize the United States over its domestic political bickering.
“We demand that the U.S. side, as the issuing country of the major reserve currency and the largest economy in the world … should undertake its due responsibility,” Vice Finance Minister Zhu Guangyao said Tuesday.
He said a U.S. debt default would be a “very dangerous situation” and urged Washington to address interest payments as a priority should that occur.
Chinese state media has gone even further, with the official Xinhua news agency calling for a “de-Americanized world”.
“What may also be included as a key part of an effective reform is the introduction of a new international reserve currency that is to be created to replace the dominant U.S. dollar,” it said.
China has been seeking to make its own yuan unit more accepted internationally but its lack of free convertibility means it is far from rivaling the mighty dollar, analysts say.
The Xinhua editorial also called for emerging market economies to have a greater say in multilateral institutions such as the World Bank and International Monetary Fund.
“Stagnation in Washington … has again left many nations’ tremendous dollar assets in jeopardy and the international community highly agonized,” it said.