The US freeze on Russia’s foreign exchange reserves could prompt China, Saudi Arabia and others to dump their US bond holdings. Washington is doing a disservice when it comes to the internationalization of federal debt. Who will fund the world’s largest military machine if the dollar loses importance?
Japan and China tend not to agree very much when it comes to economic strategy, geopolitics, or how to deal with Western idiosyncrasies. But Joe Biden brings Tokyo and Beijing together on one thing: their combined $2.4 trillion in US government bonds, which are now suddenly being called into question. It’s about the move by the US President to freeze a significant portion of Russia’s foreign exchange reserves as punishment for Vladimir Putin’s invasion of Ukraine. In Biden’s words, Washington “is preventing the Russian central bank from defending the Russian ruble, rendering Putin’s $630 billion war fund worthless.” According to some calculations, more than half of this money is out of Putin’s reach.
US government bonds are falling in value
What worries Tokyo officials is that this action could make the $1.3 trillion in US government debt worth a lot less. According to recent talks with senior Bank of Japan officials, the decision to divest Putin of billions in state assets will likely result in China, Saudi Arabia and other regimes in Biden’s crosshairs reducing their holdings. Officials stress that Japan would resist the urge to dump dollars — at least for now.
But the safety of Tokyo’s stash of US Treasury bonds complicates the year ahead for BOJ Governor Haruhiko Kuroda and Prime Minister Fumio Kishida. For Japan, the immediate concern is a rise in US bond yields, which will shake global markets and corporate confidence. Already, the potential impact of Putin’s attack on Ukraine calls into question everything Asian governments thought they knew about 2022. The impact on inflation, which is already rising sharply, and the strained supply chains are making the stock markets nervous.
China is considering further investments in Russia
The stock exchanges in Shanghai and Shenzhen are particularly in the focus of international investors. The benchmark CSI 300 index is down 27 percent from its peak 12 months ago, drawing comparisons to the stock market crisis of 2018. That year, the composite index fell more than 25 percent as mainland growth slowed and the trade war intensified intensified with the USA. The slide over the past 12 months is being driven by the collapse in real estate markets and fears that President Xi Jinping’s “zero Covid” policy will dampen growth. Ukraine also harbors risks. The People’s Bank of China (PBOC) is concerned that its latest easing measures could clash with rising commodity prices, particularly oil and gas. Reports that China is considering buying or increasing stakes in Russian resource and energy companies could anger Washington officials.
This week, the New York Times quoted US Commerce Secretary Gina Raimondo as warning that Washington could take “devastating” action against Chinese companies that help Russia evade sanctions. The specter of a heightened conflict between China and the US could push the CSI index further into the red. At the same time, Russia would need China’s help in converting its $24 billion in International Monetary Fund reserves into cash. These assets can only be exchanged into five currencies that the IMF classifies as “free use”. And the US, the European Union, the UK and Japan will not help Putin. If Xi does so, he could also face sanctions against China.
China worried about investment in the US
But Xi’s government is not the first to worry about the safety of its massive US debt holdings. In 2009, then-Prime Minister Wen Jiabao made a remarkably rare public appeal for US officials to do better with the vast Chinese state wealth held in US Treasury bonds. “We made a huge amount of loans to the United States,” said Wen. “Of course we are concerned about the security of our assets. To be honest, I’m a little worried.” He urged Washington “to live up to its words, remain a credible nation and ensure the safety of Chinese assets.”
Is the dollar becoming less important?
The US sanctions against Russia, especially with regard to financial reserves, could therefore lead to more and more countries shedding their dollar assets (and maybe also those denominated in euros or pounds?) and instead yuan renminbi and assets denominated in them to buy. Because US sanctions are not effective there and Beijing is trying to anchor its own currency more firmly internationally. This is not necessarily what Washington would like, but it is very likely to happen. However, this means that the Americans will no longer have an important means of exerting pressure on their opponents on the international political stage. The use of the “fiscal nuclear bomb” against Russia was the first step in this direction. But what happens when Americans can no longer get their IOUs sold? Who then finances the massive war machine with the world’s largest military budget?