It has been conventional wisdom that China, Japan, and other countries that run trade surpluses with the US, which means they fund our overconsumption by buying assets like US Treauries, would never restrict the flow of credit to us because it would lower their exports and hurt their growth. We’ve long been leery of the idea that unsustainable trends will have a life eternal, and Brad Setser has a simple reason why this process is self-limiting. Our foreign funding sources aren’t just lending us money to buy their goods; they are also providing the funding for interest on the loans extended for past imports. At a certain point, the interest payments become so large relative to the value of the exports that the deal no longer makes sense.
The day of reckoning may be approaching well before Setser’s tipping point. And the trigger is much simpler. We look like a lousy risk. The Freddie/Fannie conservatorship, the Lehman bankrutpcy, and the rescue of fallen Asian powerhouse AIG has, not surprisingly, lead to a reassessment of the US’s creditworthiness.
Yu Yongding, who has advised China’s central bank, urges Japan, China, and Korea to forge an agreement not to dump US bonds. Yu says in no uncertain terms that the Chinese are worried about their US holdings and see a US default as a real possibility.
We’ve said before that the US is in the same position as Indonesia and Thailand circa 1996, except we have the reserve currency and nukes. The precariousness of our position is now evident to all, save perhaps the average American citizen.
From Bloomberg (hat tip reader a):
Japan, China and other holders of U.S. government debt must quickly reach an agreement to prevent panic sales leading to a global financial collapse, said Yu Yongding….“We are in the same boat, we must cooperate,” Yu said in an interview in Beijing on Sept. 23. “If there’s no selling in a panicked way, then China willingly can continue to provide our financial support by continuing to hold U.S. assets.”
An agreement is needed so that no nation rushes to sell, “causing a collapse,” Yu said. Japan is the biggest owner of U.S. Treasury bills, holding $593 billion, and China is second with $519 billion. Asian countries together hold half of the $2.67 trillion total held by foreign nations….
“Whether some kind of agreement between them to continue to hold Treasury bills is viable, I’m not sure,” said James McCormack, head of sovereign ratings at Fitch Ratings Ltd in Hong Kong. “It would be unusual. If it became apparent that sovereigns in Asia were selling Treasuries the market would take that quite badly, it’s something to be avoided.”…
China’s huge holdings of U.S. debt means it must bear a large proportion of the “burden of sorting things out” in the U.S., Yu said. China is not in a hurry to dump its U.S. holdings and communication between the two nations every “couple of days” is keeping Chinese leaders informed and helping to avoid a potential panic, he added.
“China is very worried about the safety of its assets,” he said. “If you want China to keep calm, you must ensure China that its assets are safe.”
Yu said China is helping the U.S. “in a very big way” and added that it should get something in return. The U.S. should avoid labeling it an unfair trader and a currency manipulator and not politicize other issues, he said.
“It is not fair that we are doing this in good faith and are prepared to bear serious consequences and you are still labeling China this and that, accusing China of this and that,” he said. “China knows what to do. We don’t need your intervention.”
The U.S. financial crisis had taught China a lesson and that was: “Why are we piling up these IOUs if they may default?” China’s economic expansion strategy, which emphasizes export growth that has led to trade surpluses and the accumulation of $1.81 trillion in foreign-exchange reserves, is the main problem, said Yu.
“Our export-growth strategy has run its natural course,” he said. “We should change course.”
Anonymous 
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Very interesting post Ma’am.
I guess its time for game theory practitioners to come into the play.
It is very lucrative option for marginal holders of US assets (Asia ex Japan, China – AXJC) to cash in on this “window” of opportunity and diversify into other currencies. So in essence it will be China and Japan caught holding the bag.
One way to attempt this – they better get together at a global level and unwind this mess step-wise. That will be a much better bet.
Other way is to buyout all others in the world and concentrate the holdings between China and Japan and then use consensus based un-wind. Politically this seems a little wierd idea to me.
But only China and Japan doing it will be a problem. My guess is China will wait till the overall exposure touches 4 trillion dollars (1.5-1.8x current exposure). Before it comes to the global table. Actually earlier the better – so we can move on and start the recovery process.
Further – if we want to see the light of global recovery at the end of this tunnel, we will need Chinese consumer (and Indian too) to come to the party. American and European consumers cannot and should not take any more burden of consumption.