China looks warily at US debt deal

With the US set to avoid a default thanks to a last-minute debt deal, its biggest foreign creditor might be expected to breathe a sigh of relief, writes Simon Rabinovitch.

But China has been remarkably consistent in its view throughout the debacle, and it sees little reason to celebrate. From the vantage of Beijing, the dollar has been saved today, but its future remains as precarious as ever.

In a short commentary

on Tuesday, the People’s Daily, the official newspaper of the Communist party, gave an unusually positive assessment of the dollar’s short-term prospects.

“The credibility of US sovereign debt has steadily declined since the eruption

of the subprime crisis,” it said.

“However, because it still has hegemonic status in the international monetary system, all countries have no choice but to recognise the dollar as hard currency.”

With the eurozone crisis deepening, the Japanese economy struggling to recover and emerging markets wracked by inflation, the case for investing in dollars remained strong, the paper said.

“So even though the credibility of US Treasuries

is shaky in the short term, and its rating could be lowered by rating agencies, its credit foundation has not changed, yet.”

But looking further down the road, the People’s Daily was much less sanguine: the US economy was stuttering, its unemployment rate high and the government was heavily reliant on loose monetary policy instead of fiscal stimulus.

The debt problem would only get bigger, it warned.

It concluded: “Although

the US has basically avoided a default, its sovereign

debt problem has not been solved. It has just received a reprieve and will continue on a worsening trend. This will cast a shadow over the US recovery and pose an even bigger danger to the global economy.”

So what’s a worried China to do?

There has been mounting evidence this year of a

drive by Beijing to diversify its foreign exchange reserves away from the dollar and into other currencies, including the euro, in spite of the troubles that European debt faces.

China Investment Corp, the country’s sovereign wealth fund, has also made a strong case to get a bigger slice of the bulging reserves to manage.

And the government is encouraging companies to strike out on their own and make acquisitions with dollars.

China is not about to abandon the dollar.

However, the debt-ceiling fiasco has registered loudly and clearly across the Pacific.

Already trying to consume fewer US government bonds, Beijing’s loss of appetite is set to accelerate in coming years.

By Simon Rabinovitch