US and China: collusion collapsing?

6 August 2011

Standard & Poor’s has downgraded US rating. Credit agencies may not be particularly credible themselves, but markets will take notice nevertheless and react accordingly. While I’m not an economist, and indeed I have to profess total ignorance about the topic, I am fairly certain that the world economy is in a terribly uncertain state. When reading reports and opinions, they usually come in one of the following two modes: pessimistic panic-mongering or blithe optimism. Neither of these is particularly reassuring.

More than what the not-so-credible credit agencies produce, what China says is important for the US economy. After all, China holds a lot of US bonds. As an ignoramus in economics, I always thought that there was a collusion between the US and China. I’m not a conspiracy theorist as such, but it seemed to me that China kept buying US bonds in return for an artificially low exchange rate for the yuan which helped Chinese export. Every so often, they would accuse each other of currency manipulation or economic mismanagement, and play enemies for domestic consumption or for diplomatic posturing.

Perhaps China has too much US bonds, in other words the borrower is in a stronger position than the lender, because of the sheer volume of credit / debt, therefore it has too much to lose. China wouldn’t want to see devaluation in the US bonds, even if the dollar-yuan rate is maintained, and as its economy becomes less dependent on the over-exuberant US consumers importing things from China. The bonds are no longer purchased for to get the cycle going, but become important asset in international bargaining. Economic power usually translates into political and military power, and China has been amassing a lot of arms and options.

Looking at this from side, the term Chimerica comes to mind. Prof. Ferguson predicted that this marriage will end in a divorce. The question really is not whether the divorce will take place, but when and in what terms. It will be interesting to see what will happen over the next few years, as the divorce process takes place.