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Debt compromise matters

Liz Alderman (Perspective) / 31 July 2011

If the debt-ceiling impasse in Washington had Americans unnerved, it became a nail-biter in power corridors from Beijing to Brussels, where the stewards of the world’s largest economies are hoping for a compromise to prevent their own finances from becoming collateral damage.

At the same time, there was widespread resignation about an inescapable reality: Even with this mess, there is still no alternative to holding to the dollar, or US Treasury securities – even if they get tarnished by a once-unthinkable downgrade.

That did not stop varying degrees of angst from welling up in Asian and European capitals, depending on how much any given country has loaded up on what is supposed to be the world’s safest debt.

China, which holds the largest amount of US debt and has the most to lose, launched a blistering attack on Washington to stop bickering and show some sense of responsibility.

“The ugliest part of the saga is that the well-being of many other countries is also in the impact zone when the donkey and the elephant fight,” the state-run news agency, Xinhua, considered the propaganda arm of the Communist Party – said in an opinion article on Friday.

Officials in Europe were more diplomatic, but recalled with a touch of irony that US leaders had admonished them just a few weeks ago to straighten out the messy politics of their own debt crisis. Their main concern is that a failure to lift the debt limit will cause the dollar to weaken further, pushing up the euro and making it harder for them to work out their problems.

Around the world, most leaders see this as a nerve-racking Washington showdown that will eventually emerge in an uneasy truce.

While no one thinks the United States will default on its debt, many are girding for the repercussions of a likely reduction in its sterling credit rating.

The Chinese government held nearly $1.5 trillion in US Treasury holdings and government agency debt as of a year ago. Since then, analysts say, China has most likely purchased a great deal more. China continues to produce big trade surpluses that bring in dollars, which must in turn be reinvested in a safe haven, like US Treasuries.

Except that they don’t seem as safe as they once did. And China knows it. While Chinese officials have largely been silent about the US debt-ceiling debacle, Xinhua warned that China may be “forced” to cut its purchases of US debt if the government were to lose its Triple-A rating.

Many experts say China has little option but to continue purchasing US debt, no matter how bad the situation, because it continues to accumulate dollars and because the other large bond markets, in Europe and Japan, are not nearly as liquid.

The sentiment is also shared in South Korea, which has recently experienced two financial crises. “You still cannot find an asset as safe as US government bonds, even if there is a credit downgrade,” said Choi Jong-ku, deputy minister for international affairs at the Ministry of Strategy and Finance.

Still, there have been signs lately that China and other foreign countries have eased their purchases of long-term debt. Whether that is a temporary move or something more serious does worry Washington.

Like China, Japan has several reasons to be jittery about the US debt crisis. There are concerns that a possible ratings downgrade could knock investor confidence in Japan’s own debt, which is already twice the size of its $5 trillion economy. And though unlikely, a default by the United States would hurt the value of Japan’s US Treasury holdings.

“As the world’s biggest economy, the US has a big and immeasurable impact on global financial markets, and Japan would not escape the damage,” Hidetoshi Kamezaki, a Bank of Japan board member, said during the week, urging US officials to strike a deal on the matter.

In Europe, officials are just as concerned about the impact of the US debt standoff on the euro.

Chancellor Angela Merkel of Germany visited President Barack Obama a few weeks ago, when he took the opportunity to press her on the need for European politicians to find a solution to their debt crisis. On Friday, she said she continues to have faith that US leaders will reach a compromise, her office said.

The view was even starker from Brussels. “Of course we are concerned, because this fuels global uncertainty, which makes it harder to dampen down the European debt crisis,” one European Union official said on condition of anonymity.

Liz Alderman is a specialist in monetary policy and macroeconomics

 
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