As President Trump runs up record levels of national debt for the US, China braces itself to take political advantage, writes Duncan Bartlett
Many of the flashpoints which ignite President Trump’s anger are in Asia. China is a common source of irritation. The President’s National Security Strategy statement in December described the Asian giant as a country which ‘challenges American power, influence and interests’ and which ‘attempts to erode American security and prosperity’.
Some countries respond to Trump’s outbursts with expressions of denial, outrage or dismay. Others hurl back insults in return. Yet China’s sophisticated propaganda machine has stayed relatively quiet. Perhaps that is because China has the option of an economic response that is far more powerful than words: it can threaten to put the squeeze on America’s debts.
Much of the money America borrows flows from China. By October 2017, China owned $1.1 trillion dollars’ worth of US Treasury bonds, accounting for more than five per cent of the total Federal Debt. America owes a similar sum to Japan.
When, in mid-January, there were rumours that China might scale back its lending through its purchase of US Treasuries, there was a spate of alarm among bond traders. What would happen, they asked worriedly, if China changed its mind about lending money to the United States?
America’s need for loans from Asia has increased because the US Central Bank, the Federal Reserve, is tapering off its purchases of Treasury bonds, which it bought to stimulate the economy following the global financial crisis. Now that the economy is growing again and the stock market is at record highs, the focus is on bonds and the debts they represent.
The Centre for Economic and Policy in Washington projects that the national debt will rise by a further $1.5 trillion over the next decade, largely due to a tax cut approved by Congress in December. President Trump said it fulfilled a promise to ‘give the American people a big, beautiful tax cut for Christmas’. But like many extravagant presents, the real cost will have to be reckoned with long after it is delivered.
In return for its loans, China gains a steady flow of US dollars, which brings stability to its own currency, the Yuan. A dollar-supported Yuan keeps down the cost of Chinese exports, which makes China stronger in terms of international trade. Furthermore, in return for its investments, China gains considerable influence over the American economy. Too much influence, according to some people close to Trump.
Steve Bannon – who until last summer was the president’s chief strategist – was troubled by America’s debts to China. He said,‘We’re at economic war with China. It’s in all their literature. They’re not shy about saying what they’re doing. One of us is going to be a hegemon in 25 or 30 years and it’s gonna be them, if we go down this path.’
Bannon is now out of favour with the president and has made some disparaging remarks about his time in the White House. For his part, Trump refers scornfully to his one-time ally as ‘Sloppy Steve’. Yet even though Steve Bannon is banished from the Oval Office, his ideas still hold sway.
Before his fall, Bannon advocated an aggressive crackdown on China’s ‘unfair trade practices’. His supporters claim that Chinese goods such as steel, aluminium and solar panels are imported into the US at rock bottom prices. Protectionists urge President Trump to use his ‘America First’ policy to impose tariffs on those imports in order to protect American jobs.
The Chinese stand ready with a counter response. They have hinted that they could stop or at least reduce their flow of lending to America through the bond markets.
‘It’s a case of “you hurt us, we’ll hurt you, even if it also hurts us”,’ says Rob Carnell, chief economist for the Asia Pacific region at the Dutch financial group ING. ‘US Treasuries are perhaps more vulnerable to such threats by China than they might have been when the Fed was hard at work soaking up the available supply. This is no hollow threat. It now remains to be seen what the US does with respect to trade sanctions.’
However, Carl Weinberg of High Frequency Economics sees less room for manoeuvre by the Chinese. ‘China can’t move out of the US bond market. The Central Bank of China owns US Treasuries because it’s taking in US dollars as part of its trade transactions. They can’t just sell those dollars, like a hedge fund. To do that, they’d be selling those dollars for other currencies and that’s intervention. They are the biggest holders of US Treasuries in the world and they have no reason to undermine that market.’
As for China’s President Xi Jinping, he dreams of the day his nation’s economy grows larger than that of the United States. He also aspires to become the world’s premier economic leader through a spirit of international cooperation, which he contrasts with Trump’s protectionism. President Xi also recognises that China’s strong influence on the US financial system brings it many benefits, politically and economically.
Yet China’s own approach towards inward investment is cautious. Foreigners own less than two percent of Chinese shares and bonds, far below the levels of foreign ownership seen in other countries. The Chinese government tightly controls access to its markets for political reasons. It is also demanding a greater role for the Communist party in the decision-making process of state-owned enterprises.
Many foreigners are wary of putting their money into an environment where communism mixes with capitalism in complex and unpredictable ways. As a result, China’s bond market – the world’s third largest – is almost entirely excluded from the main global bond indices.
Those barriers to entry means the US holds little sway over China’s domestic economy. Nevertheless, America gains significant benefits from China’s outbound investment, as well as a steady supply of cheap Chinese consumer goods and the reassurance that China will keep lending it more than a trillion dollars, at least for the time being.
President Trump, however, is unlikely to write to Beijing, thanking his Chinese counterpart for his generosity. Meanwhile, President Xi is patiently waiting for China’s investments to bring him both advantage and reward.
Duncan Bartlett is a former presenter of World Business Report on the BBC World Service, specialising in Asia, and the current editor of Asian Affairs