China is now America's largest creditor

Wednesday, November 19, 2008

China is now America's largest creditor

America is the largest debtor nation in history. And given the economic weakness in the global economy right now, the debt load is likely to get worse. Recently, China surpassed Japan to become America's largest creditor.

The Chinese, who rank a mere 100th in per capita income, save so much money that they are able to buy massive amounts of U.S. Treasuries and other American assets to help the United States fund its huge current account deficit. Many have warned that this is a risky relationship, with both China and the United States bearing large burdens. However, for now, the two nations are mutually dependent for future prosperity.

China is now officially the US government's largest foreign creditor after overtaking Japan, in a development that signals Washington's increasing reliance on Beijing to save its economy.

China became the largest foreign holder of US Treasuries, owning $US585 billion ($A897.1 billion) worth as of September, according to US Treasury Department figures.

But, analysts warned on Wednesday, neither country should be celebrating the development, which underlines serious imbalances in the global economy.

"China's GDP per capita ranks around 100th in the world but it is actually subsidising the world's richest country," said Zhang Ming, an economist with the Chinese Academy of Social Sciences, a government think-tank in Beijing.

Zhang argued that becoming the largest foreign holder of US Treasuries is only an illustration of how serious the imbalances are in China's overly export-driven economy, rather than an indicator of its strength.

"What China is doing involves high risks," he said. "When the debts become massive, there are always more risks for the creditor - that's by no means symmetrical."

China's ever-growing trade surplus, a major source of its massive foreign exchange reserves that is mostly made up of US dollar assets including Treasuries, hit a monthly all-time high of $US35.2 billion ($A53.98 billion) in October.

Throughout the third quarter, China piled more than $US81.1 billion ($A124.37 billion) into Treasuries - the safest US assets it could find - while dumping bonds from government-affiliated agencies, such as Fannie Mae and Freddie Mac, said Brad Setser, an economist at the Washington-based Council on Foreign Relations.

That contrasted with the second quarter when China bought only $US13 billion ($A19.94 billion) of Treasuries while buying $US17 billion ($A26.07 billion) in agency bonds and $US20 billion ($A30.67 billion) of corporate bonds.

"That is a huge swing - and frankly a destabilising swing," Setser wrote on the council's website. "The notion that sovereign investors are always and at all times a stabilising force in the market should be put to rest.

"China has clearly kept (its exchange rate) stable - and been a big source of demand for Treasuries. But it has been a seller of other assets in a time of stress," he said.

However, China is not likely to suddenly dump US government bonds because now it would only be hurting itself, said Qing Wang, a Hong Kong-based economist for Morgan Stanley.

"If you're the largest holder of one particular asset, it's very hard for you to change," Wang said.

The ongoing global financial turmoil has shown that "supersized" foreign reserves are the best way to ensure economic stability, he said.

China, with the world's biggest reserves at $US1.9 trillion ($A2.91 trillion), sees Treasuries as safe and relatively liquid, Wang said.

"The US needs help and I think China and Japan want to help. They don't see an alternative to the dollar right now," said Andy Xie, an independent Shanghai-based economist.

However, the US Treasury bond market is not risk-free, he said.

"This is another bubble and it will burst," he said. "It's just a matter of time. No bubble lasts forever."

Japan, previously the largest holder of US Treasuries, sold off $US20 billion ($A30.67 billion) worth over the third quarter, and as of September held $US573.2 billion ($A879.01 billion) worth. That is down from a peak of $US699 billion ($A1.07 trillion) in August 2004.