From Dr. Desmond Lachman.
Sir, One can certainly empathise with Chinese frustration, as well articulated by David Li, about the US Congress’s very poor handling of the US budget deficit and debt ceiling issues (“Beijing should cut back its lending to Washington”, October 16). However, Mr Li’s call for China simply to cut back on its lending to Washington would not appear to be in China’s own economic interest.
As the world’s largest holder of US Treasuries and as the principal financier of the US external deficit, any decision by China to diversify out of US Treasuries would have a major adverse impact on both US bond prices and the US dollar. By so doing, it would cause large losses on China’s massive dollar holdings, which is the very thing that Mr Li is trying to avoid by suggesting that China diversifies out of the dollar.
Of equal concern to China should be the consequences of any such decision on the rest of the global economy. A shift out of dollars towards the euro would almost certainly result in a further sharp appreciation of the euro. This would seem to be the last thing that an enfeebled European economy needs right now and it could very well trigger a renewed intensification of the euro sovereign debt crisis.
If China seriously wanted to reduce its dollar holdings, it should seek to do so through a co-ordinated effort with the US to redress the underlying saving and investment imbalances that give rise to the need for China to continue accumulating dollars. This would require a serious effort by the US to reduce its budget deficit. However, it would also require substantive measures by China to promote domestic consumption as well as to permit a greater appreciation of its currency.
Desmond Lachman, American Enterprise Institute, Washington, DC, US