Suddenly that $3 trillion of currency reserves looks like a bad idea.
Make that very bad for China, as investors display an obvious preference for yen over dollars. That the IOUs of a debt-ridden, aging, politically adrift nation smarting from a huge earthquake and nuclear crisis seem safer than U.S. Treasuries says it all.
Many investors still see China’s monster currency stash as a strength. They reason that China is fortified against financial Armageddon. In reality, China is trapped and struggling to find exits that don’t exist. Sell dollars for Greek debt? Right. Swap into Italian commercial paper? Perhaps not. Find enough spare Swiss francs to diversify into? Good luck.
There’s always Japan. Two immediate problems come to mind. One, 10-year bonds yield a piddling 1.06 percent, about a third of the return on comparable U.S. bonds. Two, with about 95 percent of Japan’s debt outstanding tucked under tatami mats at home, China couldn’t get its hands on enough to make the exercise worthwhile. Bond markets elsewhere in Asia are either too small or too illiquid to help.
As 2011 unfolds, the Bretton Woods II architecture that Asia created after the 1997 crisis isn’t just crumbling ― it’s putting trillions of dollars of state wealth at risk. Romantic notions about returning to the original Bretton Woods world of the gold standard are unrealistic in a global system as leveraged and nontransparent as ours. So is saving its successor, which saw Asia establishing de facto pegs to the dollar and amassing mountains of reserves to protect them.
No one played that game with greater skill and alacrity than China. An undervalued yuan is the glue that powers the world’s No. 2 economy. But it’s getting harder to keep it up as Federal Reserve Chairman Ben S. Bernanke flirts with another round of quantitative easing, or QE3, and Treasury Secretary Timothy Geithner borrows to the hilt.
What’s more, it’s getting more expensive by the day. Nothing makes that clearer than recent warnings by Standard & Poor’s and Moody’s Investors Service. Both are considering yanking the U.S.’s “AAA” rating. It’s great to see S&P and Moody’s not only showing some spine, but also being out in front of the U.S.’s deteriorating fiscal condition.
The idea that any economy deserves a top rating today is just laughable. More and more, Chinese officials are realizing the joke is on them. The $1.2 trillion in U.S Treasuries held by China is but one part of the punch line. The other is the enthusiasm with which China has been buying debt issued by Greece, Portugal and other weak euro links.
All this has led to fascinating diplomacy. China now implores the U.S. to safeguard the dollar. When Secretary of State Hillary Clinton visits Beijing, U.S. debt is as much on the agenda as human rights. Europe looks to China to help its ailing economies avoid the need for an International Monetary Fund bailout. Japan curries favor with Washington with pledges not to dump its own dollar holdings.
Just as China was a huge winner after the Sept. 11 terrorist attacks on the U.S., it has thus far come out on top since the 2008 financial crisis. The U.S. spent the years after the attacks waging pointless and pricy wars and alienating much of the world. China made the most of that time cultivating friends and scoring energy and commodity contracts. Now, China is again filling the void, building roads, bridges and power grids around the world to strengthen ties.
Loading up on European debt is a case in point. The motivation is more politics than economics.
Yet economics tends to trump the programs of politicians and their calculations. Such was the case with the domino effect in Asia in the late 1990s. In Indonesia, it unseated President Suharto. In South Korea, financial chaos helped a former dissident, Kim Dae-jung, ascend to the presidency.
It’s the paradox of our times. Those who want a share of the global economy must be willing to be ruled by the whims of the millions of nervous investors who drive markets. Europe is learning that lesson as credit raters trip over themselves to issue sovereign debt downgrades. The U.S., too, is seeing the limits of its ability to placate S&P and Moody’s. That’s what happens when lawmakers play politics over the U.S. debt limit.
China and the rest of Asia are caught in the middle. The region’s penchant for hoarding dollars was never a good idea, and is coming to look like nothing so much as the world’s biggest pyramid scheme. If China tried to sell, markets would crash. So, its dollar purchases add to a financial bubble the likes of which the world has never seen. Well, history’s most audacious foreign-exchange trade may be about to go bad. And it’s no laughing matter.
By William Pesek
William Pesek is a Bloomberg View columnist. The opinions expressed are his own. ― Ed.
(Bloomberg)
