US debt ceiling deal is double-edge sword for China

15:36, August 03, 2011      

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The roller-coaster debate over raising the U.S. national debt ceiling finally concluded after the two parties made compromises. The Democratic Party-led administration removed the political restraint of debt default before the general election in 2012, and the Republican Party-led House of Representatives secured a promise to cut government spending over the next decade.

The two parties had threatened each other using the interests of global creditors, staging a preview of next year’s general election. Meanwhile, the hidden trouble in the global financial market and economic recovery has temporarily been avoided.

The second round of quantitative easing adopted by the Federal Reserve ended one month ago, and the newly released U.S. second-quarter economic growth rate fell far short of investors’ expectations, standing at only a little more than 1 percent. Debates about the risk of a second economic slump in the United States and a third round of quantitative easing monetary policy can be heard without end.

Given the situation, raising the debt ceiling will undoubtedly boost the confidence of investors. It is foreseeable that even if the economic growth of the United States loses its momentum, the third round of the quantitative easing will unlikely be adopted in the near future. As the economic growth of the world's major economies is decelerating, the U.S. debt ceiling deal is also good news to the world economy.

The confidence of investors was already particularly fragile because the international financial market was repeatedly attacked by the European sovereign debt crisis in the first half. The international financial market was in urgent need of the debt ceiling deal. This is why governments around the world, international economic organizations and even Wall Street all imposed pressure on the two parties of the United States government.

Global expectations for a deal to raise the U.S. debt ceiling show that the U.S. dollar remains the leading international currency. Republicans and Democrats have ignored the interests of creditors, trying to coerce the other side into submission. However, creditor countries have no choice but to increase holdings of U.S. debt.

Unlike the southern European countries suffering from debt crises, the United States does not need tight economic policies or the financial support of international organizations and other countries, and the American people do not need to tighten their belts. As the issuer of a world currency, the United States has easily solved the debt crisis with an unreal 10-year commitment. Therefore, the dollar-centered international monetary system in the post-crisis era must be reformed, not to mention that the United States was responsible for the global financial crisis.

Although the compromise deal to raise the U.S. debt ceiling has temporarily removed the Sword of Damocles hanging over the global economic recovery, the U.S. debt problem remains a hidden danger in the world economy. The U.S. debt limit has risen from 6.4 trillion U.S. dollars nine years ago to 16.7 trillion U.S. dollars at present. In addition, the United States has promised to cut its annual deficit over the next 10 years by more than 3 trillion U.S. dollars.

Whether it can fulfill its promise remains to be seen. If the United States cannot tackle the massive debt through economic growth, tax increases and spending cuts, it will suffer from rising inflation, and the U.S. dollar will continue to depreciate.

The United States raising its debt ceiling is a double-edged sword to China. In the short term, the U.S. economy avoids suffering from a "double dip" and introduces the third round of the quantitative easing policy, which will reduce the global financial market risk. This is conducive to China's steady economic growth because the United States is one of China's most important export markets and is also conducive to the security of China's U.S. dollar assets and keeps the exchange rate of the RMB against the U.S. dollar stable.

In the long term, the current dispute between Republicans and Democrats on the debt ceiling warns China that the United States will ignore the interests of creditors for the needs of domestic political struggles.

The United States is facing a dilemma between default and increasing debt. If one day the United States meets the domestic political obstacles on cutting debt and is facing a choice between default and passing on debt, China's circumstances will be far worse than now.

It is undoubted that changing the existing pattern of intensively holding U.S. dollar assets is necessary. However, it is more important to change the trend of continuing to increase U.S. dollar assets in the future, which requires fundamental adjustments in the economic development model.

By Li Xiangyang, director and researcher of the Asia-Pacific Institute under the Chinese Academy of Social Sciences, translated by People's Daily Online

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