Why China and Japan are praying the US won't default CNN (2023)

Hongkong CNN—

as clockTickTowards an unprecedented US debt default, world The second and third largest economies are watching in horror.

China and Japan are the largest foreign investors US national debt. They collectively own $2 trillion of the $7.6 trillion in US government debt held abroad -- more than a quarter.

Beijing ramped up its US Treasury purchases starting in 2000, when the US effectively backed China's entry into the World Trade Organization, sparking an export boom. That brings in a lot of dollars for China, and they need a safe place to keep them.

US Treasuries are widely regarded as one of the safest assets in the world, while Chinese holdings of US Treasuries have surged from US$101 billion to a 2013 peak of US$1.3 trillion.

For more than a decade, China has been the United States' largest foreign creditor. But as tensions with the Trump administration escalated in 2019 and Beijing reduced its holdings, Japan overtook China to become the year's biggest creditor.

Tokyo is holding now $1.1 trillion, China's $870 billion, Then The high risk means both countries are vulnerable to a possible fall in the value of US Treasuries should a doomsday scenario unfold in Washington.

"Japan's and China's large holdings of US Treasuries could hurt them if their value falls," said Josh Lipsky and Philip Meng, analysts at the Atlantic Council's Center for Geographical Economics.

The devaluation of government debt will lead to a reduction in the foreign exchange reserves of Japan and China. That means they have less money to pay for essential imports, service foreign debt, or prop up their currencies.

But they said "real risks" would come from the fallout from the global economy and a possible US recession after a default.

"This is a serious issue for all countries, but poses a particular risk to China's fragile economic recovery," Lipsky and Meng said.

After an initial upswing in economic activity following the abrupt lifting of epidemic restrictions late last year, China's economy is now in crisissputteringAs consumption, investment and industrial production showed signs of slowing.deflationary pressuresThe situation has worsened as consumer prices have barely changed in recent months. Another big problem is soaringunemployment rateAmong young adults, it was a record 20.4% in April.

Meanwhile, the Japanese economy is showing signs of recoveryEscape from stagnation and deflation, has plagued the country for decades.

devastating effect

Even if the US government runs out of money and takes extraordinary steps to pay all the bills - which Treasury Secretary Janet Yellen says could happen as early as June 1 - the likelihood of a US default remains slim.

Some US lawmakers have done sorecommendedPrioritize bond interest payments to the largest bondholders.

However, this comes at the expense of other obligations, such as paying state pensions and salaries to state employees Alex Capri, a lecturer at the National University of Singapore Business School, said it would help avoid major debt defaults in countries like Japan and China.

And there is no clear alternative to deal with the rising market Volatility investors can swap short-dated bonds for longer-dated bonds. According to the Atlantic Council's Lipsky and Meng, this could benefit China and Japan as their holdings are concentrated in longer-dated US Treasuries.

However, broader financial contagion and recession pose a greater threat.

"A debt default in the US would mean lower Treasury prices, higher interest rates, a weaker dollar and increased volatility," said Marcus Noland, executive vice president and research director at Peterson. Institute for International Economics.

"It could also coincide with a decline in US stocks, heightened stress in the US banking sector and heightened stress in the real estate sector."

It could also cause problems in the interconnected global economy and financial markets.

China and Japan depend on the world's largest economies to support domestic businesses and jobs. The export sector is particularly important for China, as other economic pillars - such asproperty- haltingly. Exports account for a fifth of China's GDP and provide jobs for around 180 million people.

Despite rising geopolitical tensions, the United States remains China's largest retail partner. It is also the second largest in Japan. US-China trade in 2022record high$691 billion. Japan'sExport to the United States10% growth in 2022.

"If the U.S. economy slows, the impact will spill over through trade, such as suppressing Chinese exports to the U.S., and result in a global slowdown," Noland said.

deep concern

Bank of Japan Governor Kazuo Ueda expressed concern on Friday, warning that a US debt default would upset various markets and have serious consequences for the global economy.

"The BOJ will work to maintain market stability in line with its commitment to respond flexibly to economic, price and financial developments," he told parliament.Reuters.

So far, Beijing has been relatively quiet on the matter. China's foreign ministry on Tuesday said it hoped the US would "practice responsible fiscal and monetary policies" and avoid "risk shifting" to the world.

Published by China's state news agency XinhuaSplitEarlier this month, the "symbiotic relationship" of countries in the US bond market was highlighted.

"If the US defaults on its debt, it will not only damage US credibility but also cause real economic losses for China," it said.

There is nothing Tokyo and Beijing can do but wait and hope for the best.

Capri said a rushed sell-off in US debt would be "self-defeating" as it would significantly increase the value of the yen or yuan against the dollar, leading to a "spite" in export costs.

long-term benefit?

Longer term, some analysts might say that a potential US default could prompt China to accelerate its efforts to create a global financial system that is less dependent on the US dollar.

The Chinese government has struck a series of deals with Russia, Saudi Arabia, Brazil and France to increase the use of the yuan in international trade and investment. A Russian lawmaker said last year that the BRICS countries, namely China, Russia, India, Brazil and South Africa, are looking into creating a common currency for cross-border trade.

"This will certainly serve as a catalyst for China to continue its efforts to internationalize the renminbi and urge Beijing to redouble its efforts to include its trading partners in the newly announced 'BRIC currency initiative,'" Capri said.

However, China faces some serious hurdles, such as controlling the amount of money that flows in and out of the economy. Analysts say Beijing has shown little willingness to fully integrate into global financial markets.

Derek Scissors, senior fellow at the American Enterprise Institute, said: "A strong push towards de-dollarization will lead to ... more volatility in yuan transactions."

The latest data from the international payment system SWIFT shows that the yuan Global trade finance was 4.5% in March, while the US dollar was 83.7%.

"There is still a long way to go before there is a credible alternative to the dollar," Lipsky and Meng said.