Name: Liu Zhuowen Student ID：S07504

Research paper supervisor:Dr.Seku Conde

Department of education    Minzu University of China

2007-2008 Academic Year

 

 

 

Abstract:

Any influence of china keeping lending the US money requires an awareness of their historical and contemporary context. An understanding of the situation and the essential of this action in particular helps to answer the following questions: (1) what is the situation now of Chinese foreign exchange reserve and the US Treasury bond? (2) How does china keep lending money to America, in other words, what is the essential? (3)What is the influence of this action to both China and America? (4) What changes of attitude and of focus or even actions might help the relationship between China and America in the future? The argument is as follows: Some Americans occasionally argue if it has profit or loss that relies on foreign governments which controlling the money so heavily. At the same time, Chinese people also argue that such deal to them whether it is value. Constitutionally, the U.S. Congress has increased national debt limit repeatedly with its own logic, which, absorb and use maximally the international capital. In fact, the huge bond issue, especially overseas bonds, composes a major driving force to U.S. economic growth. Anything else, this essay is based upon literature research.

    

 

 

Key words: China, US Treasury bond, America, national debt, foreign exchange reverses

 

 

 

 

 

 

Ⅰ. Introduction

U.S. trade deficits make the world economic situation further complicated. The United States is the most flexible and adjustive fastest economic entity in the world and its market is full of vitality. Poor countries, such as china, have become the financiers of the United States, which sounds interesting. China holds huge of U.S. treasuries, in other words, the United States owe a huge debt of China. This matter sounds strange. This is because the United States is the richest world's big country; China is still a great poor States.       

What is the matter? Do developing countries provide the funds willingly? Why do so many Chinese transport the money to the rich United States, and lend cheap funds available to the private house owners in United States? This essay will draw out some of the reasons and essential for the influence of china keeping lending money to America. It will do so by examining how the mechanism work helps answering the following questions. (1) What is the situation now of Chinese foreign exchange reserve and the US Treasury bond? (2) How does china keep lending money to America, in other words, what is the essential? (3)What is the influence of this action to both China and America? (4) Finally, in conclusion, if this action sustain, what attitudes and actions might help to improve the matters?

Ⅱ. What is the situation now of Chinese foreign exchange reserve and the US Treasury bond?

For China

In the year of 1996, the first time, China has accumulated 100 billion U.S. dollars of foreign assets, mainly held in dollars[1]. By 2001, this number has doubled. From then to now, China's foreign exchange reserve has also increased by six times, becoming the world's largest foreign exchange reserves States. Until now, China has foreign exchange reserves 320 billion U.S. dollars, of which, 80.9 billion U.S. dollars for the purchase of U.S. treasury bonds[2]. According to the statistics, China has become the second largest U.S. treasury holders States, only second to Japan, not to forget that its economic scale is China's nearly two-fold, but ahead of the United Kingdom. China’s investment to the United States is the most conservative one, the mainly products is in the low return rate, such as government bonds and federal bonds, rather than prominent high-risk investment. Because the bonds supported from the U.S. government is considered the world's safest investment. Their interest rates are lower than corporate bonds. In the past two years, their annual interest rate is 4% to 5%, and it can not keep up with the U.S. dollar’s depreciation rate which against the RMB with 5 percent to 6 percent[3].

At on time, national savings is also an indispensable factor to this situation. So far China has the world's highest national savings rate, China's savings rate is 50 percent[4]. It sounds staggering! In the time of peace, any country may not have such a precedent. This does not mean that the average family income is half of its savings. Although China's personal savings rate is so high, most of China's national income is almost invisible, which by the way of "store" preservation as the form of foreign currency in the national Hands. However, because the rapid development of China's economy and the restrictions of consumption, most people are still feel they are become richer.

Judging from these above, we can conclude that this is a classic example that the poor countries support the payment to the rich ones. The one with net loan is the poor China; another one with net borrowing is the affluent United States. Anyone who is sensible and clear may see that who afford the huge economic risk and sovereign risk. Needless to say that, china is the answer with no doubt.

For America

Second, let us look at the U.S., huge budget deficit is a major feature of U.S. economy. At present, the balance of U.S. Treasury bond is almost 34,338 billion U.S. dollars, including 1.0328 trillion U.S. dollars holding overseas. Last year, the U.S. Congress State raise the limited government bond from 59,500 billion U.S. dollars to 64,000 billion dollars, this year further improve it to 73,840 billion dollars, which is the most increase of the history[5].

Relationship

Third to explain is the relationship with each other. China's economy with foreign trade is export-oriented, and it is the leading direct investment destination in the world, so china government owns a great deal of foreign exchange, including capital and current account double surplus. In order to safeguard the foreign exchange stability, it implements compulsory settlement. If there are dollars come in to convert themselves into Yuan, the central bank of china must produce a large number of Yuan instead of large number of foreign exchange; of course, the central bank will also issue central currency and raise deposit reserve. Nevertheless, there is still a large number of surplus liquidity of RMB. Even worse, the result will be the rise of the real estate prices and the bubble of the stock market. For china, buying U.S. treasury bonds is the only choice. In addition to the reduction of domestic inflation, the united States use the money to sell bonds to buy China-made goods, so that china’s factory workers could continue to work, reducing the unemployment rate. At the same time, for china, which buying the U.S. dollars not only for the bonds interest but also hedge against the inflation, after all, the United States is the superpower one. In this way, China and the United State’s economy is two-way, who can not live without each other.

Ⅲ. The essential that China keeps lending money to America

Why does China keep lending money to America? It seems hard to explain, America politicians call Chinese godless communists and all manner of odiously ethnic oppression, but reluctant to admit them to get into the World Trade Organization. At the same time they interfere with all of china’s efforts to buy high tech weapons from Israel and South Africa and European nations. Tracing the history of U.S. dollars - from the hands of U.S. consumers in China's factories, and then return to the U.S. Treasury auction, this situation can easily be answered.

For china, as the current situation, it is precisely that abundant of foreign exchange flow into China supporting the dollar exchange rate stability. Because, in the new process of depreciation of the dollar, China keep purchasing a considerable number of U.S. treasury bonds. And in the past year, the U.S. dollar against other currencies weighted average exchange rate dropped 20 percent, China's net loss up to 10 billion U.S. dollars in direct[6]. As for the Chinese government, the main reason to buy U.S. treasury bonds is as follows: because that china is not focus on the interest rates in investment, but expect to stabilize the national currency against the dollar, in order to protect the country's export industry. Thus, to make the Yuan not increase its value, there will be two main ways. The first way is sell off Yuan on a large scale in the market or buy massive dollars. Looking in this way, this method can not be sustained. The other and the only available way is purchase large number of U.S. treasury bonds annually to prevent the rise in the RMB exchange rate. Such is what happened.

For America, the most direct and effective way for the budget deficit from the government is to issue currency for deficit financing; as for the trade deficit, the United States in order to reduce the deficit, they need to curb domestic demand and depreciate the dollar. Both of the two aspects need the depreciation of the dollar. That does not mean a case of crabs. For U.S., the dollar devaluation makes it in a good position to be trade with EU. They can inhibit import and stimulate exports. In other hand, the U.S. investors have been reducing the amount which holding the nation debt, the low interests is the main reason.

Now, China has a "dilemma": If it continues to buy dollars, from an economic point of view, it would be a very foolish action. Because the bonds in United States is such a low-return, but if it stop buying the United State’s bonds, or even sell it, the dollar will be further devalued, then, China must be sufferer heavier losses. China is one of the largest partners trading with U.S. According to the U.S. Department of Commerce in November 2004 published data, the U.S. trade deficit with china is the first one in all nations[7]. Since China adopt a fixed exchange rate system, the Yuan directly pegged to the U.S. dollar, so the depreciation of the dollar is no help in balance Sino-US trade. In addition, U.S. import large quantities of Chinese goods, all of them, because, China have a comparative advantage in human resources, and also with its relatively low prices of commodity, which forms a huge trade deficit between United State and China. Since China bought a lot of U.S. debt, if the depreciation of the dollar, briefly, bond holders has lost a great cut, coupling with the rise in interest rates, the price of debt will decline further. According to the British "Financial Times" estimates, if the RMB raise its value in 10 percent, the Chinese government will bear the amount of 50 billion U.S. dollars capital loss, and if the U.S. interest rates rise by 2 percent, China will further loss of 30-50 billion U.S. dollars. In results, the total loss is 80 to 100 billion U.S. dollars[8]. Of course, the calculation above has not concluded the export losses with the devaluation of dollar. In such circumstances, the Chinese government has little to choice.

Ⅳ. What is the influence of this action?

At the mention of the influence of that, we have to know the attitude of the government both China and America. Chinese government has declared that its currency, the RMB, shall trade against the US dollars at a fixed rate. It seems that China is willing to insist even though the European Central Bank, the Swiss, the Japanese, the Canadians, all have dropped their valuations of the dollar, the US dollars is worth as much to them as ever.

How does the money used in America?

Let us find out how does the money used in America. Firstly, The Bush government has thrown industrial production worldwide by literally blowing up high-tech equipment in the desert, using up gas and diesel, and then driving up the worldwide price of oil. They also sale the armaments increasingly worldwide, do costly search to track and recover special fissionable material that might be used to set off unauthorized nuclear strikes. This worldwide, high-tech, heavy-metal, rocking out comes at some cost. “It takes five pounds of food to deliver one pound of food to soldiers in the field. The ratio in Iraq is without doubt more like a thousand-to-one.”(Donald Henry Rumsfeld, 2004)[9]Commodity prices are raising worldwide, as always rise in wartime, to be context, the current wars are incredibly wasteful. As to America, they use the money to the war, and the killing is such expensive, especially when the victims are being killed individually, as in Iraq. The USA Congressional Budget Office released a report that the United States for Iraq and Afghanistan war costs enormously, and the government debt burden continue to increase, to some extent, the situation is that "to borrow money to fight". There are some statistics: “reported that from 2003 to 2005, Iraq and Afghanistan war spending an average of 93 billion U.S. dollars annually, until the year 2006, it grew to 120 billion U.S. dollars, and last year it reached to 171 billion U.S. dollars. Moreover, the Bush government applies to Congress for war funding for this year as much as 193 billion U.S. dollars. Since 2001, "September 11" incident, Congress approved the war spending reached total of 691 billion U.S. dollars, of which 440 billion U.S. dollars for the war in Iraq. At the same time, since Bush as president in 2001, the debt of U.S. government, and raise from 5.6 trillion U.S. dollars at present to over 90,000 billion dollars[10]. But the Bush administration refused to increase the tax to kill the war costs, the increasing in expenditure on the war in fact all turn to the government debt. In fact, the U.S. government was borrowing money to fight. This year the U.S. government would pay the debt interest charges as high as 234 billion U.S. dollars. If the U.S. troops in a long-term in Iraq, the debt issue will become increasingly deteriorating, coupled with the rising of social welfare and medical costs, the next 10 years of the U.S. government-debt interest will be paid 2.7 trillion U.S. dollars[11].

In the next place, they bring the money into anti-terrorism. As we all know that terrorism with high tech is the new cold war that giving enormous boost to intelligent Weapons and Equipments. The San Diego foundation for the preservation of defense industry power and influence in technology has wasted $180 Million trying to make a computer system for the FBI[12]. In my mind, it will never work, because a computer system can’t run on lies and bullshit. So sad but true, information sellers are also bringing the economics of the information economy more clearly into focus.

Thirdly, the magical production of money from the housing market by a succession of refinances driven by the lowest interest rates, stimulate the Americans spend a mass of money. The constraints on that expansion are found that when the amount of money America borrows drops dangerously close to equal to or less than the total amount of money America owes to other countries. Whenever that happens, the dollar drops in value. This year, on July 13, the United States Department of Housing and Urban Development Minister Jackson visited Beijing. He said: "At present the United States who owns their own property has reached 70 percent." The budget of this department for this year is 34 to 36 billion U.S. dollars, half of which, for the low-cost Housing subsidies.( Minister Jackson,2008, July 13)The purpose of his trip is to persuade Chinese to buy U.S. mortgage-backed securities. In some way, this action which borrowing money from China is to realize their real estate dream.

No harm but benefit

Constitutionally, it now appears that U.S. Congress has increased national debt limit repeatedly with its own logic, which, absorb and use maximally the international capital. In fact, the huge bond issue, especially overseas bonds, composes a major driving force to U.S. economic growth. It in favor of the balance of international payments and stabilize the exchange rate of U.S. dollar. In long views, continuing to run this policy is a advisable action. Judging by appearance, the United States is the world's largest debtor country, but, in fact, it is the largest international convergence and circulation of capital. Moreover, the cost of U.S. Treasury is very low, and the risk is minimal.

Anyhow, in a way, this action china lending money to America does not bring harm but benefit to America. First of all, it is hard to see how China can be blamed for job losses when America's unemployment rate as 4.5% which is close to its lowest for decades[13]. Trade with China may affect the composition of jobs in America, but it has little impact on total employment. It is true that some workers are harmed by trade with China, just as there are some losers from all international trade. By holding its exchange rate artificially low, china is approving the jobs environment and save the United States not to run a huge trade deficit. And the American economy overall is better off, so in theory there is ample room to compensate any losers. Next, not increases in value, Yuan protect the U.S. dollar. If there is a 10% revaluation of the Yuan which were matched by all other Asian currencies, the dollar's trade-weighted index would fall by 4%. Yet, the 19% decline in the dollar's trade-weighted index since early 2002 has failed to trim the deficit[14]. Again, Chinese imports doe not effect the America production. There is little overlap between American and Chinese production, so American goods cannot replace Chinese imports. Instead, other countries, such as Indonesia and Vietnam, would probably replace the Chinese. Shifting purchases to higher-cost producers amounts to imposing a tax on American consumers.

This is just a simple economic action without hostility from china

Some people think that Chinese hold nearly a quarter of U.S. treasury bonds, which is "a powerful weapons" to United States. In fact, the effect which China bring to America is limited. However, take Japan for explain, "Arms" is an illusion. Japan's foreign exchange reserves are the largest holder of U.S. treasuries States, amounted to 321 billion U.S. dollars. However, Japan has never controlled the dollar, and the yen can only be saw in sharply rise or down. Not to mention the influence to the U.S. economy. They can only sit in their own bubble corner seeing the U.S. economic prosperity. That can say easily, so do china.

Ⅳ. The prospects of the economic relationship between America and china

Present situation both China and America should face

We can not ignore that china are still a poor country, a lot of demand for its own country has not yet been met, but it would allows 1 trillion U.S. dollars from a youth place flow into a mature place where is rich. For instance, Shanghai and Washington have the similar climate, but its public schools have no heat in winter, we will see 40 children sitting in the classroom, everyone is wearing a thick coat. Take another example, Beijing’s climate is more like Boston, on the winter evening, thousands of people crowded by the roadside, enduring a long wait, and then struggling onto a crowded and desperate bus, spending a few hours on the road in congestion. This is the sample of Chinese cities. Better schools, more parks, better health care, cleaner air and water, and even a smoother city sewer, there is still far from that. The levels of personal income are in the same case. The average wage of the factory workers is about 160 U.S. dollars per month[15]; still the income of the farmers is even account the small part of the workers. Most Chinese people think that they are advancing, but their starting point is very low.

Something vigilance

Meanwhile, china should keep vigilance that: a huge U.S. Treasury bond is the weakness of China in fact. For example, once the Sino-US relations due to the deterioration of Taiwan or other issues, China may face the economic sanctions and blockade from U.S., then, the huge U.S. assets debt hold in Chinese may be frozen. In addition, 80.9 billion U.S. dollars[16], equivalent to two-fifths of China's financial revenue in the year 2001[17], and then, there will be a potential financial risk at home.

Predictions

What will happen if Chinese do not deal with this "weakness"? If the Chinese authorities do not engage in issuing the treasury bonds into infrastructure, but uses the money to buy U.S. treasury bonds, it will continue to enhance the United State a strong position in the international capital market, and China will be always in a weak position. China will swallow both long and short-term deficit. At the same time, if the Chinese people do not have more investment channels, and the operating of the current Banks and other financial institutions efficiency still in such a low level under the circumstances, the 10 trillion Yuan savings may wasted unknowingly, or flow secretly out to abroad[18].

Ⅴ. Conclusions

What might improve the economic relationship between China and America? This conclusion offers a few speculations on this subject.

Firstly, we should realize the situation now in Chinese foreign exchange reserve and the US Treasury bond. However, cause for alarm is limited, because the action is the only and available measure in such circumstance, the economic relationship between China and America is so close, everything improper will destroy if ,because ,they go through thick and thin together.

Secondly, to understand and consider the essential that China keeps lending money to America is the foundation for intercourse between China and America.

Thirdly and finally, some actions must be taken. As we know, adjustment of the RMB exchange rate is indeed a difficult task, the Chinese maybe have to pay a price. At present, China is pegged to the U.S. dollar due to a fixed exchange rate system, but even a fixed exchange rate system can also make a difference, the RMB could try to expand the floating range. However, any changes should be careful waiting an appropriate opportunity for appropriate changes. Step up the research in establishing a flexible Yuan exchange rate mechanism, meet the reasonable request from enterprises and individuals, then reduce the level of the net outflow of domestic funds, all of them should be effective.

To sum up, the prosperity of U.S. economic is built on "borrowed money and borrowed time". Therefore, whether the U.S. economy could sustain or growth stability will largely depend on the Central Bank in other countries and regions such as China, Southeast Asia, Japan and European countries. That means, it depends on if these countries are willing to continue to buy U.S. assets (such as purchases of U.S. government bonds, etc.) for Americans to spend money.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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