Why China is worried about a potential U.S. default

An employee counts money at a branch of Industrial and Commercial Bank of China Limited.

This week, China’s vice finance minister made a carefully worded request to U.S. lawmakers to please ensure the safety of China’s investments.

In comments to the Chinese press last year, Zhu Guang Yao was less cautious, bluntly spelling out the ramifications for China: “If America’s fiscal cliff problem isn’t managed well, it would probably reduce China’s GDP by 1.2 percent,” Zhu said.

This precise estimate is a sign that Beijing is watching the U.S. crisis very carefully -- quite possibly with a calculator -- to assess potential damages. As it stands, China has nearly $1.3 trillion of U.S. Treasury bills. Japan is close behind at $1.1 trillion.

“I don’t think the Obama administration will be very worried that Beijing will in fact sell those bills and use that money to buy other things," said Willy Lam, professor at the Chinese University of Hong Kong.

He thinks Beijing has little choice. After the crash in 2008, China began investing more in euros. When the EU’s economy hit the skids, China warily moved back to U.S. dollars. For all its faults, the U.S. economy remains the best investment for the world’s other top economies. But Lam said the first U.S. default on debt in 225 years would probably force Beijing to make some tough decisions about where to put its money.

“What Beijing could do is, I think, gradually downsize its holding of U.S. treasury bills," Lam said. "But this will be a long drawn out process.”

That’s because a third of China’s foreign exchange holdings are parked in U.S. dollars, and a big sell-off would hurt China’s economy at a time when the country’s already dealing with its own slowdown.

About the author

Rob Schmitz is Marketplace’s China correspondent in Shanghai.

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