China and the World, Talking Point

Beijing floored by US ceiling

Xi steals limelight at APEC but China frets about its dollar debt holdings


John Boehner: 144 of the Speaker of the House's Republicans voted to default on US debt

Photo calls at APEC conferences usually rouse the mildest of attention and normally that’s only thanks to amusement at the garish shirts that some of the leaders look to be wearing under sufferance (something that we remarked upon in WiC44). But in Bali this month the buzz was less about what was being worn at the summit and more about who hadn’t turned up, after Barack Obama stayed at home to face the crisis over the federal shutdown and a looming sovereign default.

In his place, he sent Secretary of State John Kerry, who soon looked suitably uncomfortable in a long-flowing Balinese shirt. A deep shade of purple, it may even have reflected Kerry’s mood as he was steered to the outermost fringes for the traditional photo. While Kerry stood on tiptoe at the back, Chinese president Xi Jinping was front-and-centre, beaming. If a picture really tells a story, the moment was full of symbolism, with American influence clearly subordinate.

Meanwhile, as the biggest holder of US debt, the Chinese also wanted their voice heard in Washington, as fears grew that the Americans might not raise their debt ceiling. As the week dragged on, patience wore thinner. Anger grew in the Chinese state media that the rest of the world could be dragged down by dysfunction in Congress.

Thankfully, the unthinkable didn’t happen and with just a few hours to spare before the midnight deadline a deal was brokered on Wednesday to raise the ceiling (though only till February) and end the government shutdown. Though left dangerously late, markets were still relieved that the immediate threat of America defaulting on its government bonds had passed.

Not that anyone has emerged from the debacle with much confidence in the current state of US governance.

“Our country came to the brink of disaster,” said Senate majority leader Harry Reid. Veteran Republican Senator Lindsey Graham made perhaps the most significant admission when he told CNN in the wake of the deal “our system here is completely broken”.

Indeed, the Chinese remain worried that this won’t be the last time US politicians flirt with default – with it likely we could go through a repeat of the exercise early next year. Notably, 144 Republican congressmen voted against Wednesday’s disaster-averting deal (a greater number than those who voted for it). As HSBC’s chief economist Stephen King points out, perhaps the scariest outcome of the week: “Many Republicans voted on Wednesday night in favour of default.”

All in all then, it wasn’t a great week for Uncle Sam’s image abroad…

Back to APEC: the no-show was a blow to American standing in the region?

Obama regretted that he had been forced to cancel “critical meetings in Asia” and accepted that the debt ceiling row was tarnishing the US reputation. “Whenever we do these things, it hurts our credibility around the world,” he admitted. “It makes it look like we don’t have our act together. And that’s not something we should welcome.”

He missed out the APEC Leaders Meeting in Bali on October 7-8, followed by the East Asia Summit in Brunei over the following two days.

The impact is likely to be felt in two main policy areas. Firstly, the no-show could lead to further delays in Washington’s efforts to seal the so-called Trans-Pacific Partnership (we discussed the TPP in WiC172). Beijing regards the TPP as an attempted sidelining of its own interests in the region (partly because it touches on a number of contentious policy areas like greater protection for intellectual property and a reduced role for state enterprises, but mostly because the Chinese haven’t been invited to join the pact). So it has opted to forge regional trade ties instead (most notably with ASEAN and Taiwan; see WiC67) and is also talking about setting up yet another trade group, the Regional Comprehensive Economic Partnership. The plan is to invite most of the TPP candidates (not America, of course), plus a few non-APEC members like India.

Aware that talks on the TPP have been dragging on for years, the Obama administration had promised to complete negotiations by the end of 2013. But without the president in Asia, there was less opportunity to push for a deal. Ta Kung Pao, a pro-China newspaper in Hong Kong, likened it to having “an orchestra without a conductor”.

As America prevaricates, China’s commercial clout grows. Peter Drysdale, who heads the East Asia Forum at the Australian National University, says that the Chinese share of East Asian trade doubled to 20% between 2000 and 2012, while the US proportion fell from 19.5% to 9.5%. It’s a similar story in Southeast Asia. In Brunei Premier Li Keqiang predicted that China’s two-way trade with ASEAN economies will reach $1 trillion by 2020, more than double last year’s amount.

The East Asia Summit focused more on security issues with Kerry calling on the six parties claiming all or part of the South China Sea to agree on a code of conduct to resolve disputes peacefully. But that rang a bit hollow. Many of China’s neighbours view Washington as an essential counterbalance to Beijing in the region, so Obama’s non-appearance rankled (one Asian diplomat privately described the decision to send Kerry instead as “stark raving mad”, according to The Economist).

Others went on record to urge Washington to stay active in the region, including Singapore’s Prime Minister Lee Hsien Loong, who explained that America plays a role “which no other country can replace: not China, not Japan, not any other power”. Hence there was extra disappointment when Obama’s team was also forced to cancel his proposed trip to Kuala Lumpur, postpone a visit to Jakarta (for the third time) and drop a planned stop in Manila.

Richard Haass, president of the Council of Foreign Relations, was concerned by the symbolism, telling that the no-show “makes a mockery” of Washington’s Asian “pivot” – supposedly a key foreign policy theme for Obama’s administration.

Without fuller US engagement in the region, Haass says, smaller countries will be more likely to bow to Chinese demands, while stronger ones like Japan will feel that they will have to take it upon themselves to stand up to the Chinese.

“One can hear the tectonic plates shifting in a part of the world destined to shape much of the trajectory of the 21st century,” he lamented.

So what did the Chinese do in Bali and Brunei?

Xi and his prime minister, Li Keqiang pressed the flesh at the two summits, as well as touching down in several Asian capitals before and after the main meetings.

Prior to arrival in Bali, Xi visited Malaysia, signing pledges to boost bilateral trade to $160 billion by 2017, up from $95 billion last year. He also met the Indonesian president in Jakarta, becoming the first foreign leader to address Indonesia’s parliament.

Pointedly, Xi sought to bolster APEC’s primacy in trade policy, arguing that it should play “a leading and coordinating role” in regional free-trade integration and warning that other arrangements should serve cooperative purposes, with “an open mind-set, not a closed one”.

Li went to Bangkok after the summit in Brunei, delivering the first speech by a foreign leader to the Thai legislature in over a decade and making more commitments to boost bilateral trade to new highs. Next, he visited Vietnam.

All of this activity contrasted with Obama’s absence, delighting the Global Times, which reported that Xi had found himself “in the driver’s seat” at the APEC gathering. The Economist agreed, describing the Chinese president as “oozing personal authority and commercial clout at every stop”, while Ta Kung Pao went further, gushing that Xi was now “the brightest political star on the Asian diplomatic platform”.

In contrast, Washington had been diminished: “America has lost an important chance to perform… the influence of the US is questioned more and more.”

What did the Chinese say about the debt crisis in Washington?

The leadership chose its words cautiously. But it has been a different story for the state media, which has used the shutdown to mount a wider critique of the United States and its political system. Liu Chang, a staff writer at Xinhua, was particularly caustic in an English-language commentary that eviscerated the Americans for a series of evils, including spying, torture and the murder of civilians. But he then turned to the specifics of the debt dispute as further evidence of Washington’s damaging impact beyond its own borders. “As US politicians of both political parties are still shuffling back and forth between the White House and Capitol Hill without striking a viable deal to bring normality to the body politic they brag about, it is perhaps a good time for the befuddled world to start considering building a de-Americanised world,” he demanded.

“Such alarming days when the destinies of others are in the hands of a hypocritical nation have to be terminated,” the commentary continued. “Instead of honouring its duties as a responsible leading power, a self-serving Washington has abused its superpower status and introduced even more chaos into the world.”

Elsewhere, some of the Chinese views were a little different?

Alongside sniping at Washington’s weakness, there were signs of self-reflection in the social media. Despite the chaos on Capitol Hill, not everyone was persuaded of the superiority of Beijing’s one-party rule. “A government that can shut down, no matter how big the impact on everyone’s lives, is a good thing,” noted one netizen. “It shows that power can be checked, and the government can’t spend money however it wants.”

Jiayang Fang, writing in the New Yorker, noticed a similar mood, citing another online contributor, who wrote: “This is the meaning of checks and balances. No single dictator makes the decision. And to think, Americans put this much effort into determining their budget and preventing waste. So much so that the entire government will close if a majority cannot agree…”

For others, Washington’s plight stirred familiar fury about graft in China. “I wish our government would shut down and let corrupt officials have a taste of it,” one person suggested. “In China, if the economy goes wrong, the ordinary workers lose their jobs,” said another. “But in America, it’s the officials who have to go home.”

But most of all, the media commentary looked at how a debt default in Washington would harm Chinese interests, sending a jolt through the international markets and driving down the value of Beijing’s dollar-denominated foreign reserves.

“A US default can be seen as a hydrogen bomb for the world economy,” Xu Hongcai, a director at the China Centre for International Economic Exchanges, told the Global Times. “It will have a deadly impact on the global financial system and damage the American image”.

Fortunately Xu thought the impact would be so horrific that the Americans “will do anything to prevent that from happening” and correctly predicted that a deal would be reached.

Despite this, there was no denying Chinese anger that they felt hostage to events. The diatribe in Xinhua made this point too, ruminating that the international community was “highly agonised” because its dollar assets were “in jeopardy”. Beijing, of course, holds $1.3 trillion of US Treasury bonds.

The situation even made for an unlikely ally in Tokyo, the second-largest holder of US sovereign debt at $1.14 trillion, with references to similar concerns from Japanese finance minister Taro Aso. “The US must avoid a situation where it cannot pay and its triple-A ranking plunges all of a sudden,” Aso urged.

Chinese frustration is that, despite the country’s rapid ascent to number two ranking in the international economy, the world’s global trade and investment is still dollar-dominated.

Take foreign reserves, where policymakers have been trying to address the conundrum of wanting to see the dollar diminish in significance, but not necessarily in value.

Is a transition already underway? Data from the US Treasury indicates that the proportion of dollar assets in China’s reserves had fallen to 49% of the total by June last year, down from 69% three years previously. But within that percentage the share of US Treasuries has actually increased since the global financial crisis.

“We started investing more in US government debt because it seemed so safe and invested less in agency bonds (especially government-sponsored mortgage companies Fannie Mae and Freddie Mac). Now, we should look at options outside US government debt,” Tang Jie, a researcher at Renmin University, told the Financial Times.

David Li, an economics professor at Tsinghua University, told the same newspaper this week that the Chinese have been too slow to diversify away from US Treasuries. Rather than continuing to rack up US government debt, Li argues that China should buy 5% of the shares of the multinationals operating in the Chinese market, increase holdings of the safest non-US sovereign bonds like Germany and Australia, and purchase 5% of the shares of public utility firms in the world’s more mature markets. That would be a far better use of Chinese money, Li says.

Why hasn’t China done this before? Li’s suggestion is that Beijing sees political logic in holding US debt as a “bonding instrument”. Being Washington’s leading creditor tones down American attacks on sensitive issues (such as alleged currency manipulation or subsidies for state companies).

Despite this, Chinese calls for a wider choice of reserve currencies are getting louder. The campaign has been broadly based, including demands that China has more say at international financial institutions like the IMF (Xi renewed calls in Jakarta last week for the creation of an Asian Infrastructure Investment Bank, led by China). And at home, it puts the onus on speeding up domestic reforms needed before the yuan can take on a more prominent role in global financial markets. Earlier this month we mentioned the new free trade area in Shanghai, which is expected to serve as a pilot zone for testing freer convertibility of the renminbi (see WiC211).

And although the timing looks coincidental, the People’s Bank of China signed another major swap agreement last Thursday, worth Rmb350 billion ($57.43 billion) with the European Central Bank, marking another effort to continue the internationalisation of its currency (for more on this process see our Focus Issue: Ready for the RMB). The central bank has signed currency swaps amounting to Rmb2.2 trillion with 22 countries and regions, according to Xinhua.

Yet the renminbi can hardly claim to be an imminent threat to the dollar as the world’s major reserve currency. It ranks 8th as a traded currency with just a 1.49% share (40.14% globally for the dollar) and is 12th in payment terms (0.84% share versus the greenback’s 37.93%). Similarly, it doesn’t feature in the foreign exchange holdings of many central banks. According to IMF data, only 3% of forex reserves fall into the ‘other currencies’ category in which the renminbi would be classified.

Then again, that looks likely to change.The debacle over the debt ceiling and the American government’s credit (hitherto unthreatened since 1791) feel to some like an epochal moment. Almost a century ago the First World War struck a blow to sterling’s preeminence. The brinksmanship in Washington this week might one day be regarded as the beginning of the end of the dollar’s dominance and another foothold in the slow but sure rise of the renminbi (which hit a historic high against the dollar this week).

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