Chinese officials are understandably very unhappy with the irresponsible confrontation shown by their U.S. counterparts when they discussed the country’s national debt. Unfortunately, discontent is irrelevant to international finance. The danger that awaits the United States is that after raising the country’s national debt ceiling, any measures to improve the dire financial situation will make no sense. An important lesson for China to learn now is that it is time to get rid of its dependence on the dollar.
China is concerned about the possibility of a U.S. default for many reasons. First, China is the largest holder of U.S. debt bonds, and any default or downgrade by the United States would mean a huge financial loss for China. However, even after a positive decision is made on the country’s national debt, there is a risk that US debt will continue to grow to the point where it all started, and then there will be nothing left but to erase this burden with the help of inflation. Since China has little to do with the U.S. debt bonds it already has, at least it can change its course of action and ask itself: how did it fall into a dollar trap and how can it get out of it?
China has been accumulating a current capital surplus with almost no interruption for more than 20 years. This inevitably led to the accumulation of a foreign exchange surplus. It is clear that the accumulation of foreign exchange reserves is not in the interest of China. China, as a developing country, ranks below 100 on the list of countries with per capita incomes and the loan of money from the world’s richest country – the United States – has not been justified for decades. What’s worse, China, the country with the largest foreign direct investment in the world, returns to its creditors the money borrowed at a high cost by buying U.S. debt bonds instead of importing goods and services.
China has large reserves of assets denominated in foreign dollars, as well as a significant share of liabilities denominated in yuan. With this structure of foreign exchange assets and liabilities, China’s international investment position becomes vulnerable to any depreciation of the dollar against the yuan.