The U.S.’s new AA+ rating from Standard & Poor’s is still higher than the one assigned to the Middle Kingdom. S&P has China’s debt rating stuck at AA-, the fourth highest level, due to its “sizable” contingent liabilities in its banking system.
China’s own system is jammed with rotten debt held in off-balance sheet state enterprises. Its countryside is littered with eerie, empty ghost towns. And Moody’s Investors Service says last month that China’s local debt was understated by hundreds of billions of dollars.
Despite that, the People's Daily said S&P’s downgrade of the U.S.'s credit rating "sounded the alarm bell for the dollar-denominated global monetary system.” China owns an estimated $1.16 trillion in U.S. debt. China prints yuan to hold down its value so as to keep its exports dirt cheap. It then uses that extra printed currency to buy U.S. debt.
Here are estimates to keep handy as this debate rolls along:
*China’s debt-to-GDP higher than Portugal’s ratio: China likes to say its debt-to-GDP ratio is 17%. Not so fast. The respected Beijing-based research firm Dragonomics says it is 89% of GDP, worse than Portugal’s 83% of GDP, and the U.S.’s 79% by 2015. Stephen Green, China economist at Standard Chartered Bank, figures China’s total debt, including contingent liabilities, is 77% of GDP. China’s balance sheet is notoriously murky.
*China's local government debt understated: It may be 3.5 trillion yuan ($540 billion), bigger than its state auditor has estimated, Moody's said last month.
Moody's said it discovered more potential loans after it found discrepancies in figures given to it by Chinese authorities. China's central bank alone holds an estimated $1.16 trillion in debt, and the government has already increased credit in the system to a reported 200% of GDP.
Mansoor Mohi-uddin, managing director of foreign exchange strategy at UBS, had this to say about why the dollar will continue to keep its reserve status in the world markets:
* US Treasury market’s depth and liquidity was why it was the one large financial market to function smoothly during the global financial crisis of 2008. And even throughout the debt ceiling and downgrade crisis, U.S. ten-year yields remain at historic lows, 2.6%.
*Foreign currency markets are either illiquid, unstable or not transparent to accommodate central bank reserve flows. The eurozone’s problems have kept the euro on dubious footing, with the European Central Bank shouldering the burden of keeping it strong by raising interest rates. Japan’s massive debts, the largest in the world, have kept the yen on unsound footing. Swiss debt markets are tiny. And the Chinese government’s tight, protectionist capital controls hinder inflows to the renminbi.
*U.S. has solid political relations with most of the planet’s largest foreign reserve-holding countries. That keeps the dollar on sound footing, too. Those countries are Japan, South Korea, Saudi Arabia, Kuwait, Qatar and the United Arab Emirates.
*Strong U.S. defense gives these countries shelter, making it in their interests to protect the dollar, and their own holding, in the global currency markets.
*U.S. has flexible monetary policy: True, this upsets monetary hard-liners who detest the Federal Reserve’s quantitative easing policies that has blown out its balance sheet to a seventh of the U.S. economy. But the U.S. central bank for now can still set monetary policy independently, unlike central banks overseas. It’s increasingly being drawn into political fights however. However, individual eurozone countries can’t do much on their own to alter the course of the euro to support their own economies, and they can’t set interest rates or pursue separate exchange rate policies to support their economies.
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