One surefire way to make Americans maudlin about the future of the economy is to remind them just how much of our debt is owned by China. But this week, post-downgrade, a good way to make a Chinese economist feel maudlin might be to remind him of the exact same thing. As Reuters points out, "The old adage says you have a problem if you owe the bank a thousand dollars, but the bank has a problem if you owe it a million." And we owe China about $2 trillion, in fact. China has also invested a great deal of its currency surplus backing troubled European countries. These might have seemed like ironclad investments not so long ago, but now there's a very real chance that China won't actually get all of its money back.
That's not just a scenario that plays out in case of default: Even the worry that governments might not potentially be able to pay back their creditors starts a vicious no-confidence cycle:
Faltering western demand saps China's own export-driven growth, its hard cash savings are undermined by previously unthinkable credit concerns, and the likely policy response to western demand shocks will be more money printing.
That money printing, according to HSBC chief global economist Stephen King, simply weakens the dollar while keeping bond yields low, transferring the debt burden to foreign creditors who see the dollar value of their assets dwindle for the sake of supporting US exports and growth.
China wouldn't have many options left to it in that case: Printing money would exacerbate inflation domestically. Trying to sell off its American holdings might set off a panic — one economist told Reuters the country might topple global financial dominoes on purpose, if it feels "cornered" enough.
What's "neither a borrower nor a lender be" in Mandarin?