Critical China should put its own house in order, analysts say

By Andreas Landwehr Aug 9, 2011, 4:51 GMT

Beijing - While China slams the debt addiction of the United States, it could usefully examine its own unhealthy dependence on its debt surplus with the world's largest economy, analysts say.

The huge trade imbalance between the world's two largest economies has long been an unsolved problem in the global economy.

Fear of a second dip to the recession in the US should be a wake-up call to China to finally end its export dependency and rely more on domestic demand, experts say.

But instead, China, Washington's biggest foreign creditor, has been flexing its muscles.

'It's time the US tightened its belt and solved its structural problems,' admonished the People's Daily, China's main Communist Party newspaper, this week. No country can live beyond its means, the paper said.

China is worried about the value of its hoard of US Treasury bonds, estimated at 1.152 trillion dollars. The commentator emphatically warned the issuer of the world's primary reserve currency not to let it weaken in a bid to make US exports cheaper and thereby stimulate the economy.

It is a mechanism that the world's leading exporter, China, knows well. To prevent its currency, the renminbi, from rising in value, China's central bank buys US dollars from Chinese exporters and invests them in US Treasuries.

'China can't stop buying US dollars,' said Michael Pettis, a professor of finance at Peking University's Guanghua School of Management.

Pettis dismisses frequent warnings that China could quit buying US debt to put pressure on Washington.

'It would be good for the American economy if they stopped buying US dollars because that would reduce the US trade deficit,' he said. 'China, of course, would then have to allow the renminbi to appreciate and reorient its economy.'

China's leaders, however, are afraid of job losses at home if prices of Chinese exports rise. Over the past year, the value of the Chinese currency has risen by only 6 per cent against the US dollar and has even fallen against the euro and Japanese yen.

'Concern about the US defaulting on its debt may strengthen the position of those in China who favour an upwards revaluation, but there are very few signs this will happen soon,' Pettis said.

Things are bound to go wrong in such an imbalanced trade relationship, he warned, because one side cannot live with deficits forever and borrow without limit. At some point it will be forced to ease the burden of its obligations, be it by inflation or a weakening of the national currency. In the case of the dollar, China particularly fears the second scenario.

To reduce its trade deficit with China, which was 273 billion dollars in 2010, the US is demanding that China let its currency appreciate and make its market more accessible to foreign goods.

Cheaper imports could also spur domestic demand in China, which should be contributing more to the economy anyway and would be economically healthier. Even China's latest five-year plan calls for stimulating consumption to ease the country's excessive dependence on exports.

But with a generational change in state and party leadership planned for next year, now seems to be an inopportune time for a painful economic readjustment.

'China is at a critical juncture,' said a European ambassador in Beijing. 'It's got political change, and at the same time major economic problems must be solved.'

A foreign businessman whose company has billions of dollars invested in China expressed skepticism. 'I'm not sure whether they'll be able to get a grip on the growing complexity.'

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