Roach and Roubini: Chinese have lost confidence in America’s ‘dysfunctional economic stewardship’

Separately, both Nouriel Roubini and Stephen Roach, two leading American economists with differing views on the Chinese domestic economy, have pointed out the concern China has with the dysfunctional US political system. Increasingly, the Chinese are showing signs that they are not pleased with tying up so much of their wealth in US dollars. How the Chinese plan to act upon their concerns is another matter, however.

I should note that the US is a rich country, the largest and richest economy in the world. As such, the US is fully capable of paying its debt via the taxing power of its federal government – even if we were not in a world of fiat-based money. However, we are in a world of fiat based money and the US government owes all of its debt in a currency it creates. It could always repay those debts. The relevant questions are the soft default of currency debasement and inflation, not solvency.

Hence, the debt ceiling crisis is a manufactured crisis emblematic of US political dysfunction. As the debt ceiling crisis continues to mount expect the costs to not just be economic but geopolitical as well.

Regarding China’s concerns, Roubini wrote via Twitter that

“Biggest concern in meetings in Hong Kong: will the US default on its debt? Folks here are shocked by the dysfunctional US political system”

Echoing Roubini, Roach writes today:

The Chinese have long admired America’s economic dynamism. But they have lost confidence in America’s government and its dysfunctional economic stewardship. That message came through loud and clear in my recent travels to Beijing, Shanghai, Chongqing, and Hong Kong.

Coming so shortly on the heels of the subprime crisis, the debate over the debt ceiling and the budget deficit is the last straw. Senior Chinese officials are appalled at how the United States allows politics to trump financial stability. One high-ranking policymaker noted in mid-July, “This is truly shocking… We understand politics, but your government’s continued recklessness is astonishing.”

Stephen Green of Standard Chartered says a default or downgrade of US debt would speed China’s switch out of US dollar assets and into the euro.  Some economists believe China may well float the Yuan in the next five years (see Reuters Insider video here).

The problem, of course, is the currency peg. It’s not a matter of China diversifying its foreign currency reserves out of US dollars. That’s plain wrong. Beijing is not Washington’s banker. The Yuan currency peg’s low fixing to US dollars and the resulting trade imbalance necessitate China accumulate US dollar currency reserves. The question for China right now is not whether it will, but rather which US dollar assets it must accumulate because of the peg. If China floats, in that event, all bets would be off.