When the two US mortgage heavywieghts Freddie Mac and Fannie Mae went under, the major investment losers were the Chinese, who had invested in the US secondary mortgage industry to the tune of roughly $US500 billion.
China has for a very long time been financing America’s debt by stockpiling US dollars — 2 trillion of them — and investing in previously secure bonds like the ones issued by the big US mortgage companies. The idea was to hedge against the severe financial meltdowns of the Asian currency crisis in 1997. But now these two giants have collapsed, causing China serious headaches.
The American Government took steps to prop up the Chinese investments, giving them a slight reprieve. If not, China could have quickly lost the roughly 10 per cent of its GDP held in those assets and all hell would’ve broken loose.
China isn’t just insuring itself against a ’97-style crash, it’s also financing America’s foreign debt. If Freddie Mac and Mae were allowed to collapse, the US dollar would go into freefall, China’s forex investment would be lost and its financial hedging strategy would be in the dustbin.
Nonetheless, the dollar has suffered during the current financial crisis, causing a depreciation of China’s forex reserves. As well, the global economic shocks have reduced export demand, the engine of and China’s economic growth, to single digits for the first time in four years. Its global maritime trade is suffering, and housing and property sectors are under pressure.
While China says that it will come to the financial aid of the US, it has suffered its own losses on paper. China Investment Corp had a stake in Blackstone, which has lost 50 per cent of its paper value, and a significant share of Morgan Stanley — down almost 20 per cent. China Development Bank’s investment in Barclays Bank doesn’t look so rosy either after Barclays dropped 50 per cent of its value.
Needless to say, the Chinese are very nervous about any further investment in America’s financial sector, but their stake in the US economy via forex reserves means that for now, they have to dish out the cash to save their own skin. At the same time, China has issued a sharp rebuke to Western leaders for their "weak financial policy discipline". It has also made regulatory changes to compel its financial institutions to officially report their foreign currency exposure to the Governement, in the wake of major losses by Chinese companies.
There has been much debate in China about how much China should come to the aid of the US, but the reality is that if it ignores America’s current plight it could lose hundreds of billions of its own dollars. A popular idea that has been doing the rounds in China is that this financial meltdown is all deliberate outside pressure for the yuan to appreciate — which would lead to China losing its exporting edge and thus its primary driver of economic growth.
This is part of a raft of theories in China about the interplay of Western foreign and economic policy. These theories rest on the idea that the West is conducting "currency wars" to bully China to open its doors and weaken its economic clout.
One analyst at the Bank of China has written that there is more to the sub-prime crisis than meets the eye:
"Tan Yaling believes that the depreciation-appreciation-depreciation process of the dollar is purposely designed. Through the quick depreciation of the dollar, America is able to weaken the Euro area economy, as well as RMB (the yuan), which may be seen as a threat in the future, and its own double deficit problem can be gradually resolved. As the appreciation range of RMB is smaller than that of the euro, the US manages to create hostility between the euro area and China, so Europe will also pressure China to allow the RMB to appreciate."
Of course it has been hard not to watch the US Government bailout without wondering whether the US has, through its draconian surveillance laws and its recent financial intervention, attempted to "out-commie the commies", so to speak. It certainly seems that Western governments, media and financial institutions are operating at a level that is consistent with centralised policy that protects "state interest". This makes the recent financial turmoil and current interplay between China and the US all the more interesting.
Put this in the context of the other major issues swirling about the US-China relationship — namely the decision by America to sell arms to Taiwan — and the situation becomes even more complex.
Agreeing to sell $US6 billion dollars worth of weaponry to Taiwan is not going to win the US many new friends in Beijing at a time when it looks like it needs a few. Nor is the stationing of the nuclear aircraft carrier USS George Washington in the Japanese naval port of Yokosuka likely ease tensions in the positioning taking place right now in the Pacific.
The Chinese leadership has been understandably indignant about the arms package development and has made their displeasure known. They have cancelled several diplomatic and military visits, saying the deal severely jeopardises China’s national security and US-Sino relations. As Shen Dingli noted, the arms deal is another interesting move that comes at the end of a Bush term and the beginning of a new administration.
Barack Obama and John McCain have both pledged their support for the Taiwan arms package, although it must be remembered just as any US outgoing administrations can put controversial deals into place, any new administration has the ability to blame the old political crowd for the policy.
So far China has stopped short of explicitly linking any financial assistance for the US to strategic issues, but it can be relied upon to connect them at some level.
The current financial crisis may be a global issue, but for these two powers it’s also very much a bilateral one.