News / Economy

As US Averts Default, Japan, China Brace for Next Dollar Drama

A man holding a mobile phone is reflected in an electronic board displaying foreign currency rates against the Japanese yen and market indices from around the world outside a brokerage in Tokyo, Oct. 11, 2013.
A man holding a mobile phone is reflected in an electronic board displaying foreign currency rates against the Japanese yen and market indices from around the world outside a brokerage in Tokyo, Oct. 11, 2013.
Reuters
Deal or no deal, the U.S. Congress' dance with default impressed policymakers and investors in China and Japan with just how vulnerable their own economic revival plans are to the next political tantrum on Capitol Hill.
 
The 11th-hour agreement on Wednesday between Congressional Republicans and Democrats to raise the limit on U.S. government borrowing and end a 16-day government shutdown also averted a default on U.S. Treasury bonds that had threatened the global economy and financial system.
 
But Congress gets another chance to hold U.S. creditworthiness hostage early next year ahead of a new February 7 deadline to approve a debt ceiling increase.
 
“We're glad a deal has been struck,” said a Japanese policymaker, who spoke on condition of anonymity. “But the uncertainty will remain and it will be the same thing all over again early next year.”
 
He and other Japanese officials say they have already developed contingency plans that include flooding Japan's banking system with cash to keep markets functioning however panicked investors become. And analysts say China, whose Communist leaders are due to hold a key policy meeting next month, may step up a push for global acceptance of its currency, the yuan or renminbi, as an alternative to the U.S. dollar in international trade.
 
“They might actually consider accelerating the process,” said Vincent Chan, head of equity research at Credit Suisse in Hong Kong. “You strengthen the case of making the renminbi a genuine international currency, because the Americans are unreliable.

Near-debt experience
 
Perhaps no two economies outside the United States have more at stake in Washington's recurring drama than Japan and China.
 
Not only are they the second- and third-largest economies, but they lend Washington more money than any other single nation. China held $1.28 trillion in U.S. Treasury securities at the end of July and Japan owned $1.14 trillion. A default would likely have devastated the value of their holdings.
 
More than that, though, both nations have adopted policies to revitalize their own economies that to some extent rely on the improving economic appetite, stable currency and increasing indebtedness of the world's largest economy.
 
China is trying to deflate a dangerous credit bubble and wealth imbalances with a series of reforms that include slowly easing controls on moving money into and out of the country and allowing its currency to gently appreciate.
 
Analysts predict investors faced with a U.S. default would try to sell dollars for yuan, forcing China's central bank to either buy up dollars at a time when the government issuing them isn't honoring its obligations or allow a rapid increase in the yuan's value that would hurt exports and worsen the country's credit bubble.
 
In a sign of such market pressure, the yuan hit a record high on Friday for a fifth consecutive day against the dollar, partly as investors worried about the economic impact of the U.S. shutdown.
 
“If China allows the yuan to rise sharply, it could be very risky given the possible asset bubbles in the country,” said He Yifeng, an economist at Hongyuan Securities in Beijing.
 
Japan, meanwhile, is trying to end 20 years of deflation and anemic growth with a blend of policies named for their chief proponent, Prime Minister Shinzo Abe. “Abenomics” relies on reviving domestic consumption and investment in part by weakening the yen, boosting the earnings and stock prices of giant exporters like Toyota Motors Corp and Hitachi Ltd .
 
A U.S. default would likely prompt investors to buy yen.
 
“That would undoubtedly pose a headwind against Abenomics, which has much depended on a weak yen and higher share prices buoyed by the feel-good mood it has generated,” said Masamichi Adachi, senior economist at JPMorgan Securities in Tokyo.

Quid pro quo
 
A default also stands to hamper a U.S. recovery and with it a nascent rebound in global exports. A default in the first quarter of 2014 would hit just as Japan's economy girds for an April sales tax increase and as China's economy loses the effects of accelerated public works spending and re-stocking of inventories.
 
There are no bond markets large enough to give China and Japan an alternative to U.S. Treasuries for the dollars they accumulate selling exports. So the prospect of another U.S. default drama next year is likely to lend new urgency to China's preferred solution: conducting less trade in dollars and more in renminbi.
 
About 18 percent of China's total trade is settled in yuan and it has registered a sharp increase this year after stagnating for most of last year.
 
Much of the increase has come in China's trade with economies outside the United States or the European Union, its biggest demand centers, although it accelerated plans to internationalize the currency with agreements this month with Britain and the European Central Bank.
 
Achieving more trade in yuan, however, means giving China's trading partners a place to invest their renminbi as easily as they invest their dollars in U.S. Treasuries now.
 
That means opening China further to foreign investment, a realization that could strengthen the hand of officials advocating faster reform.
 
“China can only be strong when its currency is a real alternative,” said Chan at Credit Suisse. “But to be an alternative you have to have an open market.”

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