A default of the US is highly unlikely, even in the current chaotic political setting in the United States, says leading China economist Arthur Kroeber, but today the risks for China are much higher than during the 2008-2009 crisis. A crisis would not offer an opportunity to build an international financial system around the Renminbi, next to the US dollar, he adds in the ChinaFile.
As in 2008-2009, a global economic meltdown would hurt China a lot. It would fare slightly better than most other countries because it runs a closed-off financial system that relies mainly on domestic savings, and is protected from the ups and downs of global financial instability by capital controls. But the impact of a U.S. debt default would still be devastating. In 2008-2009, the loss of trade finance and collapse in global demand sent China’s exports plummeting by nearly 20 percent, and upwards of 20 million workers lost their jobs.
Fifteen years ago, China’s government could respond by unleashing a massive debt-financed economic stimulus program, because the country’s debt level, at 140 percent of GDP, was relatively low and it still had significant needs for infrastructure and housing. Today, the space for maneuver is far narrower: debt has soared to nearly 300 percent of GDP, and both infrastructure and housing are seriously overbuilt.
Though severe, the economic consequences to China of a U.S. default would probably not be regime-threatening. Whatever pain the Chinese people were forced to suffer could rightly be blamed on outside forces. And in a pinch the government could still support a minimum level of growth by adding to its debt pile, since it would be borrowing from its own future, not from foreign creditors.
This leads us to the second question. If the U.S. defaults, could China create a substitute system, built around the renminbi? The short answer is no.
The U.S. treasury market is huge, and deeply intertwined with the rest of the world. (That’s why a default would be so bad.) There are $23.9 trillion in treasury bonds outstanding; foreigners hold $7.5 trillion, or 31 percent, of that pile; daily trading last year averaged $600 billion. In practice, this means it is easy for large companies and governments to hold treasuries in any amount, trade large volumes quickly, and easily obtain or dispose of as much collateral as they need for borrowing.
China’s government bond market is nowhere near big enough, liquid enough, or integrated enough with the rest of the world to substitute for U.S. treasuries. According to calculations by my colleagues, the total value of Chinese government bonds (CGBs) on issue—$3.3 trillion—is less than half the value of U.S. treasuries held by foreigners. The foreign holdings of CGBs are a mere $340 billion, one-twentieth of the country’s treasury holdings. The daily turnover of China’s government bond market is $30 billion, about 5 percent of the treasury market average.
After the 2008-2009 crisis, because it decided it was too dependent on the dollar-driven global financial system, China tried hard to internationalize the renminbi. Its efforts have borne little fruit. The renminbi accounts for just 2.8 percent of global official central bank reserves (compared to 60 percent for the U.S. dollar and 20 percent for the euro), a figure that has not changed much in the past several years. Similarly, it makes up just 2.4 percent of global trading in foreign exchange.
China has failed to internationalize the renminbi for the same reason it is relatively insulated from global financial shocks: capital controls. Bringing money in and out of China still requires permission from Beijing. From the Chinese government’s point of view, this is good. When economic conditions worsen in China, it is hard for Chinese citizens to take their money out and park it abroad. And by limiting the amount of money foreigners can bring in to China, and controlling the conditions under which they can take it out, Beijing reduces the risk that a global financial panic leads to a damaging outflow of foreign investor capital. As a result, Beijing does not have to work so hard to maintain domestic financial stability.
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