China and the US: A Case of Mutual Dependency?

There’s been a lot of interesting discussion about President Barack Obama’s Asian tour this week. And I don’t mean the controversy over whether or not the U.S. President should bow to the Japanese Emperor (though if you’ve been watching the domestic news media, you’d be hard pressed to realize there were any other issues at stake).

Far more important has been Obama’s visit to China. While the U.S. government has shied away from the more controversial topics (perhaps forced to do so by the more than $1 trillion in U.S. treasury bills currently held by the Chinese government, notes Stephen Walt). It also failed to win any concessions on the major issues it has hoping to address (again, not a surprise).

The most interesting story, though, was noted by John Cassidy at Rational Irrationality. Cassidy wrote,

Speaking at a conference in Beijing just hours before Air Force One arrived, a top Chinese financial official attacked the Federal Reserve, and, by extension, the rest of the American government for stoking another speculative bubble, which could have disastrous consequences for the global economy…Liu Mingkang, China’s top banking regulator, said the Fed’s policy of keeping interest rates artificially low “is boosting speculative investments in stock and property markets and will pose new, real and insurmountable risks to the global recovery and particularly to the recovery in emerging markets.” In particular, Liu said, the Fed’s cheap-money policy was encouraging investors to borrow heavily in dollars and then use the money to buy higher-yielding investments in other countries, such as stocks, bonds, and real estate. This “huge carry trade” was having a “massive impact on global asset prices,” Liu insisted.

Cast in this light, the United States and China appear to be in a situation of mutual dependence. The United States depends on China to purchase Treasury bills, essentially financing the day-to-day operations of the U.S. government. But China already holds more than $1.6 trillion in dollar-denominated assets, primarily U.S. treasury bills. Any decline in the value of the U.S. dollar undermines China’s position as well.

The debate over the value of the renminbi is one part of a much bigger debate over the broader regulation of the global economy, as Arvind Subramanian observes at Baseline Scenario. Efforts to resolve the financial crisis in the United States (by maintaining loose monetary policy(glossary)) drive capital into emerging markets, including China, where returns on investment are greater.

We certainly appear to be living in interesting times…

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