US debt ceiling: How risky for China and Japan?
A US default might lead China to buy American companies instead of American bonds, some analysts say.
Beijing and Tokyo
As the world contemplates the prospect that the United States might, for the first time, default on its debt, few countries have more to fear from the potentially calamitous consequences than Asian giants China and Japan.
They are the two largest US creditors, holding nearly $2.5 trillion in US Treasury bonds between them. They are also the second and third largest economies in the world, with much to lose from the collapse of world trade that experts warn could follow a default-induced freeze in global credit markets.
And they are not hiding their feelings. Chinaâ€™s deputy finance minister, Zhu Guangyao, warned at a press conference Monday that â€śsafeguarding the debt is of vital importance to the economy of the US and the world.â€ť
â€śThat is the United Statesâ€™ responsibility,â€ť he said, urging Washington to take steps before Oct. 17 to forestall a default. Â
In Tokyo, meanwhile, officials held several emergency telephone conferences with their US Treasury Department counterpartsÂ on Monday, according to the Nikkei Business Daily, a leading publication on Japanese economics.Â
Policymakers and analysts in Asia do not know what to expect in the event of a US debt default. â€śHonestly, nobody really knows what the impact on financial markets would be because there is no precedent,â€ť says Andrew Batson, an economist at Dragonomics consultancy in Beijing.
A threat to Japan's recovery
Though Japanese officials are optimistic that the standoff in Washington will be resolved quickly, that is largely â€śbecause otherwise the situation could get so tricky that they donâ€™t want to think about it,â€ť says Martin Schulz, chief economist at the Fujitsu Research Institute in Tokyo.
The governor of the Bank of Japan, Haruhiko Kuroda, warned that a default could hinder Japanâ€™s economic recovery after two decades of stagnation.
â€śIf this [budget deadlock] continues for a long time, it could destabilize financial markets and worsen sentiment,â€ť Mr. Kuroda told reporters in Tokyo Friday.
The threat of a US default comes at a pivotal moment in Japanâ€™s economic recovery under Prime Minister Shinzo Abe, who took office last year promising to pull the country out of its deflationary spiral. He has presided over three straight quarters of economic growth as exporters benefited from a sharp fall in the value of the yen, boosting their profits overseas.
Japanâ€™s recovery could be undermined, though, if a debt crisis in the US prompts investors to drop the dollar and head for the â€śsafe havenâ€ť of the yen, in turn driving up the value of the Japanese currency.
On Tuesday, the yen rose to an eight-week high. â€śI think the Abe government has every reason to fear a US default,â€ť says Tobias Harris, a Washington-based Japan specialist at Teneo, an independent advisory firm.
â€śBeyond the risk to Japanese government holdings of US debt, the flight to safety by investors will obviously result in a stronger yen, both hurting exporters and undermining the push to end deflation.â€ť
China and the dollar
Beijing, too, is worried more about the likelihood that a debt default would devalue the dollar than it is about the interest or principal payments it might lose in a default, which in any case China would expect to be temporary.
A devaluation would eat into the value of Beijingâ€™s investments in US Treasury bonds, which stood at $1.28 trillion last July, according to the US Treasury. â€śThat would be a big problem for my country,â€ť says Huang Weiping, professor of economics at Beijingâ€™s Renmin University.
A devalued dollar would also make imports from China more expensive and less easy to sell in the US, which is Chinaâ€™s second largest foreign market, Professor Huang points out.
In fact, selling anything internationally would be a problem if the US Treasury Departmentâ€™s warnings of catastrophe proved accurate. Global trade collapsed in 2008 after the financial crisis froze credit markets, and both consumers and businesses cut back on purchases.
â€śA default would be a very great shock to the world economy,â€ť says Huang. â€śChinaâ€™s position in the world economy means it would also be a great shock to its economic development, especially to its trade and investment.â€ť
As the largest foreign holder of US debt, China is in a difficult spot. It has accumulated the worldâ€™s largest hoard of foreign reserves, about $3.5 trillion, by exporting more than it imported year after year, and because the Chinese government bought exportersâ€™ dollars from them in a bid to keep the Chinese currency, the renminbi, competitively low.
Beijing then invested those dollars in US Treasury bonds, the easiest and safest place to put them. â€śChina is joined at the hip to the dollar and to the US debt market, which is the only place large enough to absorb all the dollars they have accumulated,â€ť says Patrick Chovanec, chief strategist at Silvercrest Asset Management in New York and former professor at Tsinghua Universityâ€™s School of Economics and Management in Beijing.
â€śThey are along for the ride, wherever that ride leads,â€ť he adds.
Buying businesses instead of bonds
The psychological shock of a default, however, could lead to major changes in the longer term, predicts Xiang Songzuo, chief economist at the state-owned Agricultural Bank of China.
â€śEven a temporary default would have a very deep impact on the Chinese authoritiesâ€™ thinkingâ€ť about the creditworthiness of the US government, Mr. Xiang believes.
And while diversifying official investments might be hard, given the continuing crisis in the eurozone and poor returns in risky emerging markets, a US default might lead China to buy American companies instead of American bonds, Xiang suggests.
â€śIt would make the government change the way it manages foreign exchange,â€ť he says, by reforming Chinese capital markets. Instead of soaking up private companiesâ€™ dollars, the government would encourage the firms to invest them abroad themselves.
â€śAmerica would have to open up more to Chinese investment,â€ť Xiang says. â€śEven a temporary default could have quite a significant effect on US-China relations.â€ť