China-US Relations: Why China Can't Bluff

BIG PLAYER. With US$ 1.6 trillion dollar of US treasury bonds in possession, China's Hu Jintao is betting big in United States and is being held hostage by Barack Obama and his economic policies.

The game of Poker expects the player with the strongest hand to raise the bet, control the opponents’ moves, and dictate the flow of the game.

So why could not China –as the biggest United States’ creditor with 1.5 trillion of US treasury bonds in hand– just dictate United States and tell Washington what to do? The riddle here is why China succumbed to the pressure from the United States in some of its economic policies –like appreciating its currency– whereas they supposedly have the power to direct Washington to conduct economic policies for Beijing’s benefit.

Onviously, China is anticipated to be acting something more like this: “You do what I say,” said Hu Jintao to Barack Obama, “or I’ll stop lending you money, I’ll stop buying your assets, and I’ll sell all these 1.6 trillion treasury bonds in instant.”

In fact, such conversation is not happening –because the situation is more complicated and some things are definitely easier to be said than done.

Holding 1.6 trillion of the US treasury bonds does not mean China is holding United States hostage –it could be, in some ways, the other way around. Instead of having a strong hand that allows its player to bluff and dictate the game, it turns out that the 1.6 trillion dollar US assets that China is holding right now is a devilish bug that limits Chinese policymakers from doing what they deem necessary for their economy.

In its effort to boost export and increase trade competitiveness, it is well known that People’s Bank of China –China’s central bank– has been continuously interfering the market by purchasing US dollars every time they deem the situation as necessary.

This policy ultimately leads to two outcomes. The first is the world’s economy is overwhelmed with Chinese currency, the renminbi, whose rate is excessively undervalued since there is way too much supply of the currency in the market.

The second is China hold too many foreign exchange reserves in their possession. Because China continuously purchase US dollars –and other currencies as well– and fill the market with renminbi, at the end of March 2011 China’s foreign reserves has accumulated to a astounding level of US$ 3.05 trillion; 60% of which (about US$ 1.6 trillion) composed of US dollar that comes mostly in the form of US treasury bonds.

The latter outcome is a condition that prompts a big-scale headache for Chinese policymakers at present.

If something happens to United States and their economy, China could not simply sell their US treasury bonds. Holding US$ 1.6 trillion of US dollar-denominated assets makes China the big player, hence if China sell its assets, other countries are more likely to follow suit. Eventually, this will drive down the value of China’s own assets and put their multi-billion investment at stake.

With an investment worth of more than a trillion dollar in United States treasury and institutional bonds –and some in the form of stocks–, it makes a lot of sense if the officials from Beijing are watching United States’ economic policies in vigilant state.

For example, a few months ago Chinese policymakers were infuriated to see their US dollar-denominated assets to decline in value because of the quantitative easing policy implemented by the officials of The Federal Reserve, United States central bank, who craftily depreciated US dollar to boost the United States export sector.

Just recently, the Republicans are losing their marbles as they are putting the world’s economy at bay by trying to push the United States economy into default in the protracted debt-ceiling negotiation against Barack Obama. The situation is serious: If a new bar of debt-ceiling is not set and United States goes into default, the US dollar will surely freefall and the Chinese, with its US$ 1.6 trillion of dollar-denominated assets in their stash, would be among the party that suffers the biggest economic losses.

The situation could go from bad to worse due to the fact that rating agencies like Moody's and Standard & Poor's have considered the possibility of downgrading the United States credit rating from its current rating (AAA) this year.

But, where to invest besides in US treasury bonds? No matter how worse the situation that engulfs US economy at present, the US treasury bonds remains the largest and the most liquid investment in the world. Moreover, amidst the deteriorating euro and the volatile yen, the fact that the US dollar is still considered as the world’s reserve currency should not be ignored.

At the moment, China does not really have better solution and alternative in this game. Eventually this makes any bluff from China to the United States meaningless –because the opponent, apparently, knows that China is betting loads of money in the pot with a very, very weak hand.