The Other Cost of the $700 Billion Bailout: All Foreign Credibility
the U.S. financial industry suffered the biggest turmoil since the 1930s, rumors spread that the Chinese government, which holds about $1 trillion of U.S. debts, had ordered state-owned banks to stop buying American bonds. Although the Chinese government immediately dismissed the rumors, and reaffirmed its confidence in the United States, the rumors are sending out a clear signal: this time, China won't be a willing rescuer of the United States.
The Bush administration predicted that the federal government's deficit of the next fiscal year, starting in October, will stand at a historic high of nearly $500 billion. And adding the new $700 billion bailout plan, the United States' public debt ceiling will be raised to $11.3 trillion from $10.6 trillion. With its vault empty, the administration has to hit up such countries as China and Japan. China, holding the world's largest foreign reserves of $1.8 trillion, might be the first country Treasury Secretary Henry Paulson will visit for money.
In fact, the Wall Street Journal has reported that pressure from China played a role in the U.S. government's bailout of Freddie Mac and Fannie Mae, the two giant government sponsored enterprises. The two mortgage companies owe China more than $200 billion. By bailing them out, the United States is showing China that the U.S. government is standing ready to guarantee its debt.
Overall, the U.S. debt held by China is the world's second largest after Japan, according to data from the Treasury. About 45 percent of foreign bonds held by China is related to the United States, according to Jiang Jianqing, chairman of China's biggest bank, Industrial and Commercial Bank of China (ICBC). But will China trust the United States as much as it did before the financial crisis? The answer is clearly no.
"We aim to be a strategic investor," said Jiang. "The ICBC will take good care of its purse, and has no interest in fire sale [of U.S. bonds]." And, he added, "Both China and the world's financial markets have focused too much on the U.S."
Meanwhile, China has its own trouble at home: a tumbling stock market, rising inflation and a slowing economy. Instead of gobbling up U.S. bonds, China may use its massive foreign reserves to boost its own economy. Instead of holding U.S. dollars as the dominant foreign asset, the country is very likely to replace them with the Euro, Japanese assets and gold.
What action China will take this time could be determined by China's policies during Asia's financial crisis a decade ago. In 1998, the then Chinese Premier Zhu Rongji vowed not to devalue China's currency, the yuan, to attain an 8 percent growth rate in gross domestic product (growth was 9.3 percent in 1997), and to contain inflation to below 3 percent. By boosting government investment, and at the same time holding a modest monetary policy, Zhu delivered what he promised. Facing similar external challenges this time, it is more than likely that China will take the same course.
China's two-digit economic growth speed has slowed to around 9 percent in the second quarter of this year. Just two weeks ago, the benchmark Shanghai stock exchange index slumped to below 2,000 points. Meanwhile, inflation rates stay above policy-makers' comfort level.
Because of declining consumer spending in the United States, one of China's major export destinations, many Chinese exporters are suffering from shrinking revenue. In provinces such as Guangdong and Zhejiang, some manufacturers have had to declare bankruptcy.
Facing mounting economic challenges, China is making all efforts to stabilize the Chinese economy. Wen Jiabao, China's incumbent premier, said recently in the World Economic Forum that "the biggest contribution we can make to the world economy under the current circumstances is to maintain China's strong, stable and relatively fast growth, and avoid big fluctuations."
China has unveiled a number of initiatives to shore up its stock market and bolster investor confidence. The government used its foreign reserves to purchase shares in three of its largest banks. State-owned enterprises will also be encouraged to buy back their own shares.
To boost the economy, China's central bank unexpectedly cut its base lending rate on Sept. 15 and lowered the ratio of funds that banks must set aside as reserves. Ting Lu, an economist at Merrill Lynch, said the Chinese government could cut tax and spend more money on infrastructure and housing. That means China will use more money in its domestic development, instead of buying low-yield U.S. bonds.
Also prohibiting China from investing in the United States is China's inexperience in foreign investment. By putting $3 billion of China's hard-earned savings into the initial public offering of Blackstone, a U.S. private-equity firm, China suffered the biggest holdings loss, about $1 billion in six months, as Blackstone's share prices tumbled.
The Chinese government is learning the hard way. It recently abstained from buying a big chunk of shares in Morgan Stanley, a large U.S. investment bank, which allowed a Japanese bank to step in as Morgan Stanley's rescuer. Going forward, China will become more cautious on its U.S. investments.
However, dumping U.S. assets is also unlikely, as it will only further upset their value and make China lose more money. China, then, is likely to maintain a more neutral position. It will become more scrupulous. But it could also implicitly promise not to dump U.S. assets.
The debate in China over foreign investment isn't focused on whether it should invest in overseas markets, but on how to invest. China may use its reserves to buy foreclosed real estate in the United States, or make loans to the U.S. government. Or it could buy shares in companies with stable profits. The key is maximizing the revenue, not cleaning up the mess for the United States.
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Albion Monitor October
7, 2008 (http://www.albionmonitor.com)
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