China and Japan are our two largest foreign creditors. Beijing holds $1.3 trillion in Treasury securities and Tokyo $1.1 trillion. Together, they account for 21% of all public holdings of Treasuries, and 45% of foreign lending to the US government. So what they say counts for a lot. Of course, whether they choose to roll over their Treasury exposure as it matures counts for a lot more.
Needless to say, neither is thrilled by the current shenanigans in Washington …but for different reasons.
Japan is worried that a US default would cause a decline in the US$ and a flight to safety in the ¥. Japan has spent the last year engineering a sharp depreciation in its currency as part of a last-ditch effort to revive its moribund economy. The last thing it wants to see is one of the three pillars (or “arrows”) of Abenomics, a weak yen, destroyed. (On the other hand, there’s still no evidence that the third, and most crucial, arrow–reform of antiquated corporate business practices–will ever leave the quiver.) What I find interesting about this attitude is that there’s no trace of the deference toward US interests shown by a prior generation of Japanese leaders–men who believed their loss of WWII obligated them to act this way. No surprise here, except maybe to politicians in Washington.
China is expressing concern that its very large investment in the US could lose value as a result of political stalemate in Washington. In itself, this isn’t much of a surprise, either. China has been working for several years to reduce its exposure to US government debt by spending its large surplus of dollars as fast as it can. No matter what the outcome of the debt ceiling issue in Washington, Beijing will doubtless redouble its efforts to reduce its Treasury exposure.
The way it has framed its concern, however, should be sending chills down the spines of any US entity with direct investments in China. Beijing points out that China has large investments under the stewardship of the US–predominantly Treasuries. Conversely, the US has large investments under the stewardship of China–in the form of manufacturing, distribution and retail ventures that US corporations have established there. The two governments have reciprocal obligations toward each other. The US must be a responsible steward of China’s investments; China, in turn, must be a responsible steward of foreign direct investment from the US.
The implication is that US failure in its obligation releases China from its duty.
If I’m understanding China correctly, the negative consequences for US companies with China businesses of the current goings on in Washington may be far greater than I think Wall Street realizes.
If so, very bad for the US. From a practical standpoint, probably better to get China exposure through the Hang Seng than the S&P.