China demands US tighten fiscal belt

China, which owns $1.2 trillion of US Treasury debt, yesterday called for the US to get is financial house in order

BEIJING // China demanded yesterday that America tighten its belt and confront its "addiction to debts" after losing its triple-A credit rating.

China owns $1.2 trillion of US Treasury debt, the largest stake of any central bank, and the commentary carried by the state-run Xinhua News Agency was Beijing's first official response to the rating downgrade by Standard & Poor's.

"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," Xinhua said.

It said the rating cut would be followed by more "devastating credit rating cuts" and global financial turbulence if the US failed to learn to live within its means.

"China, the largest creditor of the world's sole superpower, has every right now to demand that the United States address its structural debt problems and ensure the safety of China's dollar assets," it said.

The significance of the downgrade, and China's angry reaction to it, should not be exaggerated, said Patrick Chovanec, an associate professor in the School of Economics and Management at Tsinghua University in Beijing.

China had already expressed its concerns over the US debt crisis and Friday's downgrade was the culmination of things that "market participants already knew and have been thinking about for months", Mr Chovanec said.

"China is venting its frustrations about this, but I don't think it's going to change China's actual behaviour in terms of holding US debt."

China's accumulation of US Treasury securities "is not really driven by the attractiveness of US debt per se. The alternatives are limited and not necessarily more attractive," he said.

He said Washington has encouraged China to consider alternatives to holding US debt, such as allowing the Chinese yuan to float freely and reducing its trade imbalance with the US.

Since 2009 there has been strident criticism of China from US politicians who have argued that Beijing keeps its currency at an artificially low level to help its exporters.

The US's biggest trade deficit is with China. Last year it reached US$273 billion (Dh1 trillion), the biggest deficit with a single country in US history. In 2010, the US bought goods from China worth almost four times as much as its exports to the world's most populous nation.

However, China itself runs significant trade deficits with several of its regional trading partners, notably South Korea, Japan, Taiwan and Australia, and this has been suggested as one reason China is keen not to allow its currency to appreciate significantly.

While the downgrade in the US credit rating has enormous symbolic significance, it is not entirely clear what its financial implications will be.

Standard & Poor's is the only major credit ratings agency, apart from a Chinese company, to have downgraded the US credit rating. Dagong Global Credit Rating Company lowered the United States to A+ last November after the US Federal Reserve decided to continue loosening its monetary policy.

On Wednesday, the day after Congress finally agreed on a package of spending cuts and an increase in the debt ceiling, China's leading ratings agency announced a further downgrade to A, indicating heightened doubts over Washington's long-term ability to repay its debts.

But Dagong's much lower rating had little impact on markets. S&P's decision, on the other hand, might. Most important, the status of US Treasury bonds as risk free might be harmed.

However, because they have always been considered safe, some investment funds treat treasuries as a separate asset category. In other words, there is no need to sell them simply because they are no longer rated AAA.

The implications of the downgrade probably won't be known until tonight, when markets begin to open in Asia. Since the downgrade has been signalled for some time, the impact may not be large.

In July, S&P placed the United States's rating on "CreditWatch with negative implications". It said the US needed not only to raise the debt ceiling, but also to develop a credible plan to tackle its long-term debt.

John Chambers, head of sovereign ratings for S&P, said on Friday the slowness at raising the debt ceiling and the political infighting led to its decision. In announcing the downgrade, S&P referred to "political risks, rising debt burden; outlook negative".

China yesterday said the US must slash its "gigantic military expenditure and bloated social welfare costs" and accept international supervision over US dollar issues. Last month, China's top general, Chen Bingde, also linked America's financial woes to its military budget and asked whether paring back on defence spending wouldn't be the best thing for US taxpayers.

Such comments reflect Beijing's desire that Washington reduce its military presence in Asia. The US, rattled by China's military buildup, also routinely criticises Beijing for its fast-growing defence spending.

Xinhua also suggested a new global reserve currency might be necessary to replace the dollar, a position China has frequently advocated.

"Mounting debts and ridiculous political wrestling in Washington have damaged America's image abroad," Xinhua said. "To cure its addiction to debts, the United States has to re-establish the common sense principle that one should live within one's means."

Jitters over the US handling of its debt problems were also being felt elsewhere in Asia, said Kishore Mahbubani, Singapore's former ambassador to the United Nations.

The dean of Singapore's Lee Kuan Yew School for Public Policy said the last-minute agreement by the US Congress to lift the debt limit and avoid default has policymakers in Asia questioning the stability of US global leadership.

"It's definitely undermined US credibility," Mr Mahbubani said on Friday. "Everyone is wondering if you have such a dysfunctional political process, how can you provide global leadership. It's very dangerous for the world."

* With additional reporting by the Associated Press