WE'VE GOT THEM RIGHT WHERE WE WANT THEM:

How Serious Is the Chinese Challenge?: Despite its rise, China has lopsided financial interdependence with the US (Markus Jaeger, 15 July 2010, YaleGlobal)

While China’s rise has greatly increased its power, this has thus far translated into limited bilateral influence vis-à-vis the US. China’s most important economic-financial lever of influence regarding the US is the threat to sell off its estimated $1.4 trillion in US treasury and agency debt.

Such a move would be costly for Beijing, however, economically and financially, China would shoot itself in the proverbial foot. First, the value of its holdings would decline, and higher US interest rates would weigh on the US growth outlook, hurting Chinese exports. Furthermore, unless it’s willing to accept renminbi apprecation, China would have to find other dollar assets to invest in,as rapid renminbi appreciation is hardly in China’s interest in terms of exports and dollar-denominated US debt holdings. However, if China does re-invest in dollar-denominated assets, this would presumably help ease financing conditions in other segments of the US financial system, potentially offsetting negative effect of higher rates in the treasury market on the economy.

Second, if Beijing were to dump large chunks of US debt, it might disrupt financial markets in the short run. The medium-term impact would likely be manageable, as other official foreign buyers with close security ties to the US, including Japan and Gulf nations, would step in, albeit at higher interest rates.

Last but not least, any politically motivated fire sale of US debt would trigger a severe political backlash – and not just from the US – as well as undermine China’s standing as a reliable financial investor and economic partner.

Financially, economically and politically, Beijing would pay a high price for significantly raising US borrowing costs and it would end up paying a higher price than Washington – simply reflecting the fact that China is much more dependent on the US than vice verssa. The US has access to a more diversified investor base, with which it maintains close political relations. The US market is substantially more important to China in terms of both exports and imports than vice versa – and the Chinese export sector is relatively more employment intensive.

On the other hand, since China adds no value to the parts it assembles for us, we'll be more than happy to move on to the next cheap labor source.

Posted by Orrin Judd at July 16, 2010 5:26 PM