China Tells US To Cut Spending And Avert Turmoil

By Khalil Hanware

China bluntly criticized the United States on Saturday one day after the superpower’s credit rating was downgraded, saying the “good old days” of borrowing were over.

Standard & Poor’s cut the US long-term credit rating from the top-tier AAA by a notch to AA+ on Friday over concerns about the nation’s budget deficits and climbing debt burden.

China — the United States’ biggest creditor — said Washington only had itself to blame for its plight and called for a new stable global reserve currency.

“The US government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone,” China’s official Xinhua news agency said in a commentary.

Beijing condemned the United States for its “debt addiction” and “short sighted” political wrangling. “China, the largest creditor of the world’s sole superpower, has every right now to demand the United States address its structural debt problems and ensure the safety of China’s dollar assets,” it said.

China currently owns $1.2 trillion of US Treasury debt, the largest stake of any central bank.

It urged the United States to cut military and social welfare expenditure. Further credit downgrades would very likely undermine the world economic recovery and trigger new rounds of financial turmoil, it said.

“International supervision over the issue of US dollars should be introduced and a new, stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country,” Xinhua said.

After a week which saw $2.5 trillion wiped off global markets, the S&P move deepened investors’ concerns of an impending recession in the United States and over the euro zone crisis.

Jarmo T. Kotilaine, chief economist at the Jeddah-based National Commercial Bank, said: “The US downgrade should be seen above all as a wake-up call. This represents an opportunity and an imperative for the US to rise to the occasion by finally producing a credible plan to get its fiscal house in order. Problematically, the probability of this happening ahead of the November 2012 elections must be deemed very low.”

Nonetheless, he said, a number of established economies — including Canada, Australia, Japan, and several European countries — have gone through a similar experience. In many of these cases, politicians successfully addressed the structural weakness of the economy and managed to reform economic policymaking in ways that not only restored some of these countries to their former health but also significantly increased their resilience to future shocks.

Kotilaine said the downgrade would almost certainly amplify the downward pressure on the US dollar and push up the cost of borrowing, although these effects will be to an extent muted by the weakness of other economies and especially the euro zone crisis that will maintain the pressure on the euro.

The likely near-term impact for the US will be further economic weakness, although the exact magnitude will depend on the response, notably the nature and scale of monetary stimulus, he added.

Moreover, even with the downgrade, it is not obvious that the dollar has suddenly lost its safe-haven status in a highly uncertain world, he said, adding that previous examples of similar downgrades elsewhere suggest that an initial one-notch drop should not materially change the picture, although the US situation is complicated by the dollar’s reserve currency status and potential investor reassessment of that. Moreover, with even slightly higher borrowing costs and a political stalemate, the economy may further lose momentum which would increase the challenge of fiscal consolidation and potentially lead to another downgrade, Kotilaine said.

Kotilaine said the Chinese call for a new reserve currency was hardly a surprise, since it merely repeated earlier such calls. But the rhetoric does reflect growing frustration with the fact that the US economic model is in serious trouble and unlikely to produce a sustainable recovery in the near term. In the meantime, China will play a key role in funding US deficits, which will increase the magnitude of potential risks, should the dollar devalue significantly or inflationary pressures increase. China’s surpluses, as enviable as they are, are almost as much a manifestation of the credit-fueled imbalances in the global economy as the US twin deficits.

The impact of the US ratings downgrade on Saudi investments abroad is not clear. According to the latest June monthly report of the Saudi Arabian Monetary Agency (SAMA), the central bank’s total foreign currency and gold holdings stand at SR156.5 billion, deposits with foreign banks total SR372.5 billion, and investments in foreign securities some SR1.32 trillion.

It is hard to say how much of this is dollar-denominated but it is a significant proportion, given that dollar-denominated oil makes up the vast majority of export revenues. The so-called “independent organizations” (GOSI, PPA, government funds) have SR6.5 billion in foreign deposits and SR300.2 billion in foreign securities.

“In seeking to ensure the stability and continued growth of its own economy, the Chinese will want to protect the value of their investments. The new global reserve currency debate is above all caused by the fact that there is no obvious alternative to the dollar, especially now that the euro is in trouble. Consequently, a new currency may well have to be created more or less from scratch, a process that will be slow and complicated even if it is done under the auspices of an organization such as the IMF,” Kotilaine said.

In contrast to the Chinese criticism, France’s Baroin said France had faith in the United States’ ability to get out of this “difficult period”. Baroin said Friday’s US unemployment numbers were better than expected and so the situation was heading in the right direction.

“Therefore, one should not dramatize, one needs to remain cool-headed, one should look at the fundamentals,” he told France’s iTele.