China finances the US national debt

Debt crisis - "China will break away from the US dollar"

The state-run Chinese news agency Xinhua has asked the United States to finally tighten its belt and solve its own structural problems. Does China have to fear a possible collapse of the US economy now?
No, it doesn't have to be scared. The USA is still - and rightly so - a very solvent debtor. It is absolutely out of the question that the US will go bankrupt. Because they also have the option of paying off their debts through inflation, in contrast to Greece, for example.

China has $ 3,200 billion in foreign government bonds, around 70 percent of which are in US currency. The People's Republic thus holds around eight percent of American debt.
Yes, China is the largest single holder of US Treasuries and is suffering from the massive drop in its market price. This is initially associated with virtual asset losses. But as long as these asset losses are not realized - because the Chinese central bank remains on the paper - it does not matter. It becomes problematic if China tries to sell these government bonds on the market. But that is not yet foreseeable.

Why not?
The Chinese central bank bought the government bonds in order to stabilize the exchange rate between its own and the American currency. It intervenes in the foreign exchange market and thus creates an artificial demand for the dollar. That keeps the US currency relatively high. If it doesn't want to risk a rapid appreciation of the yuan, the Chinese central bank would have to hold back a bit from selling American government bonds anyway.

However, the rating agency Standard & Poors has now lowered its thumbs in relation to the creditworthiness of the USA. What does this mean for China?
The downgrade means that less capital flows into the US. That should continue to weigh on the US dollar. For the Chinese central bank this results in the need to buy up even more dollar-listed government bonds in order to keep the currency stable.
To finance this, China would have to increase the amount of money - create new money, so to speak, which it can then use to buy more US securities. But that would mean domestic inflation. Since inflation rates have risen relatively significantly in the last few months, there is little room for maneuver. So that's probably not an option either.

Can we also expect the money printing machine to be started in the USA - this time to reduce its own debts?
It is very realistic that the US Federal Reserve will allow a somewhat higher rate of inflation over the next few years. In doing so, it devalues ​​the high public and private debts and facilitates their repayment. However, the high inflation rates would call into question the leading status of the American currency in international markets. That would make it less interesting for China to invest in dollars.
I believe that China is saying goodbye to its close ties to the US dollar and is focusing more on a multipolar currency system. That would mean that China would shift its portfolio somewhat, from dollar-listed securities to the euro, Swiss francs or commodities. The downgrade of the US credit rating should speed up this process somewhat.

In addition, there is the negative trade balance between the USA and China. Last year the deficit was $ 273 billion.
The weaker dollar - which can be expected after recent developments - is likely to reduce the US foreign trade deficit. This will also be at the expense of China, because the USA will no longer import so heavily from China. However, this assumes that the yuan can appreciate a little against the US dollar. The first steps have already been taken, and the Chinese central bank has already allowed slight appreciations. This should reduce the imbalance somewhat, and thus reduce the US foreign trade deficit. It's a very, very slow process, though.

So far, the US has always accused China of keeping the currency artificially low. Is that going to turn around now?
In principle, it's still the same dispute. Now the US is in the more favorable situation, as the dollar is quoting weakly on its own. In the past, the yuan was kept artificially low. But the higher the US debt, the more difficult it becomes for the Chinese central bank to keep the exchange rate reasonably stable. In this respect, the Chinese government already has an interest in a solid financial policy in the USA.

What would all of this mean for us in Germany?
If China is less oriented towards the US dollar and more towards more stable currencies, such as the euro, then this should lead to increased capital flows to Europe and thus to an appreciation of the euro. This could lead to a slight dampening of exports in Germany. But that is not necessarily a problem for German consumers, because at the same time we can import cheaper from world markets.

In the context of the turmoil on the financial markets, China's stock exchanges have also suffered heavy losses in the past few days. Are the markets only reacting to developments in the USA and Europe?
At the moment we are observing very, very great uncertainty on the stock exchanges, and in some cases panic herd behavior. During the financial crisis - that is, in the past three years - the capital markets have learned to reassess risks and are now assessing uncertainties more critically than in the time before the crisis. And the markets also see risks in China. The real estate markets are overheated and there is a bubble-like development. In an environment of destabilized financial markets, it is easier for such bubbles to burst. The market slumps in China are therefore definitely also domestic reasons.

Mr. Fichtner, thank you for talking to us.

The interview was conducted by Petra Sorge.