China and The U.S. Debt Crises

Published on Author magrath

With the 113th Congress now in session and the issue of the tax increases put to bed minutes before the end of 2012, the focus of the media and the world becomes the imminent debt ceiling. The United States is rapidly approaching its borrowing limit of $16.4 trillion, and a debate and a storm are brewing. The resolution of the crisis will have implications for both the United States government at home and its creditors abroad. China, as the US’s largest creditor, will invariably be affected by both of the plans outlined by the major political parties.

The greatest risk for the United States would come from default. While the S&P downgrade of the US debt following the last “cliff” did not alter the rate at which the United States is able to borrow money (or rather, the rate at which other countries are willing to lend), a real default could increase the interest rate the government enjoys. Even a 10 basis point increase would lead to tens of billions in higher interest expenses.

The other alternative, involves raising the debt ceiling without substantive reform, leaves the avenue open for future borrowing. While the United States is uniquely immune, or at least highly resistant, to insolvency risk, the practice of continually printing money could lead to a weaker U.S. dollar in the long run. This, too, harms China, whose trade surplus with the United States is in no small part due to the comparative cheapness of producing goods in China. Absent this favorability, U.S. manufacturers would likely turn to other countries, or even within, should it come to pass that consumers are unwilling to pay higher costs for goods.

China was a vocal critic of the resolution of the 2011 debt ceiling crisis, stating that Washington needed to “cure its addiction to debts” and “live within its means.” Officials in the Chinese government also expressed some skepticism over whether or not the dollar was still fit to be considered the world’s reserve currency. It remains to be seen what China will do and say in the weeks and months to come as the 2013 cliff approaches.

2 Responses to China and The U.S. Debt Crises

  1. This is definitely a major issue. With the interconnectedness of globalization, the United States current debt situation could strain foreign relations with other countries, especially China. I wonder if how much of an impact China can make on the United States and if China can cause the United States to sign any reform policies. The potential weaken of the dollar could also strain the US-China trade relationship, and lead to the promotion of more American products. I wonder what China will do if the United States does not change or reform enough.

  2. Debt ceiling issues would affect [very] short-term debt, but only indirectly affect long-term debt, which is the majority of what China holds. So we have to be careful not to exaggerate the immediate impact on China. But as to the exchange rate …. look at what’s happened in the graph at the top of the home page of our blog!! Now in the long run the RMB may strengthen more in nominal terms relative to the dollar, but remember that our inflation is currently well below 2% pa (the latest CPI numbers are flat on a month-to-month basis, that is, 0%) while China has substantial inflation (a needed blog post by one of you!)