Debtors' leverage: China's fear of a US default
Source Marvin Gandall
Date 08/09/25/08:58

Asia Needs Deal to Prevent Panic Selling of U.S. Debt, Yu Says
Bloomberg. com
By Kevin Hamlin

Sept. 25 (Bloomberg) -- 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, a former adviser to the Chinese
central bank.

``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.

China, Japan, South Korea and others should meet soon to seal a deal, said
Yu, a former academic member of the central bank's monetary policy
committee. The talks should involve finance ministers, central bank
governors and even national leaders, he said.

``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.''

The global credit crisis, triggered by a housing slump in the U.S., has
saddled financial companies with more than $520 billion in writedowns and
losses, collapsing Bear Stearns Cos. and Lehman Brothers Holdings Inc. in
the process. Insurer American International Group Inc. and mortgage giants
Fannie Mae and Freddie Mac also were rescued by the government.

`Grave Threats'

U.S. Treasury Secretary Henry Paulson is urging Congress to pass a $700
billion plan to remove devalued assets from the banking system. Federal
Reserve Chairman Ben S. Bernanke said Sept. 24 that the U.S. is facing
``grave threats'' to its financial stability.

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.''

Currency Manipulator

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.''

China should stop intervening in the foreign currency markets and thus allow
rapid appreciation of the yuan, he said. While this would cause pain for
exporters, China could ease the transition by using its strong fiscal
position to aid those who lose their jobs. It also should stimulate domestic
demand to offset lower income from overseas sales.

Without yuan appreciation, China will continue to accumulate foreign
reserves, which means further accumulating ``IOUs from the U.S.,'' said Yu.
``This is paper and it may default and it will not increase China's national

If China doesn't allow the yuan to appreciate and continues to promote
export-led growth it will lead to confrontation with the U.S. and Europe, Yu

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