America’s Nightmare Looms in Beijing

He took a severe tongue-lashing from his Chinese counterparts. Now Henry Paulson is back in Washington, trying to fix our homemade financial crisis. How times have changed for China and for the U.S. investment scene.

Only two years ago the U.S. Treasury Secretary used to fly to Beijing regularly to lecture the Chinese about the right way to run an economy and stock markets. ‘Use debt to expand your financial potency,’ Paulson would tell Chinese banking authorities. ‘Use derivatives to make your stock markets bigger and safer,’ he cautioned them proudly as Wall Street investment banks went on a disastrous lending binge.

Now Beijing is America’s biggest banker. As we reported in the last issue of the China Stock Digest, China has surpassed Japan to become the biggest holder of U.S. debt with holdings of $585 billion in Treasuries alone. China’s economy is robust and cash-rich while America suffers through a painful recession.

America’s colossal debt helps us finance our ballooning budget deficit and recent stimulus spending. But it doesn’t end there. The U.S. may have to issue as much as $2 trillion in debt over the next year to pay for the financial-system meltdown, America’s wars in Iraq and Afghanistan, and further economic stimulus programs like the bailout of U.S. auto manufacturers.

It’s not a pretty picture. Beijing knows it and our bankers in the Chinese capital are getting worried. When Secretary Paulson arrived for his regular Strategic Economic Dialogue (SED) talks with the Chinese, his reception was chilling and unprecedented.

This time it was China’s turn to tell America to put its financial house in order. The cause of America’s financial crisis, according to China’s central bank governor is, over-consumption and a too-high reliance on credit.

Governor Zhou told Paulson bluntly that it was high time for the U.S. to rein in its huge trade and fiscal deficits. American consumers should be more like the Chinese and start saving more and relying less on their credit cards. After Central Bank governor Zhou said his piece he abruptly flew out of town, leaving the Treasury Secretary to the mercy of lesser officials.

It did get a lot worse for Paulson. The head of China’s sovereign wealth fund says he has lost the confidence to invest any part of the nation’s mountain of foreign reserves in U.S. banks. As he put it, he didn’t have the courage to invest in the U.S.

The balance of power has shifted enormously since 2005.  Back then China was forced to drop an $18 billion bid for Unocal, America’s eighth largest U.S. oil and gas production company, due to political pressure. Now America has changed its tune.

During the Treasury Secretary’s visit, Paulson welcomed “commercially based” investments by China’s central bank and it sovereign wealth fund in U.S. industries including finance. Until now, America has been blocking banks, insurance companies and brokerage houses from setting up shop on U.S. soil. Suddenly America needs every cent it can get from Beijing.

The nightmare lies in Beijing’s power to stop investing in the U.S. Even worse, Chinese authorities could ask for their money back. Pulling out more than half a trillion dollars worth of loans to the U.S. would have shattering consequences for America’s weakened economy. Washington knows it. So does China. Unless you’re a China Stock Digest subscriber, you may not be getting the facts.

The nightmare of a Chinese pullout from America’s financial system is real. A blunt remark by China’s Vice Premier was taken by many to be a threat. He told Americans to, “take all necessary measures to stabilize its economy and the financial market to ensure the security of China’s assets and investments in the U.S.” America’s previous U.S. investments have done poorly. Clearly the Vice Premier is warning that China might stop financing U.S. debt and investing in America.

Because China holds all of the cards financially, investment in the U.S. is being treated with scorn by some bank analysts. As one official said sarcastically. “ I am sure Mr. Paulson won’t treat China’s investments in U.S. Treasuries and debt markets as a threat to the U.S. economy when the U.S. desperately needs money to boost its economy now.” Blunt words indeed.
Because China’s economy continues to grow, it is seen by many as the new engine of worldwide economic recovery and expansion.

For the time being, China feels secure about its economic stability with well-capitalized banks, increasing profits among many private companies and trade surpluses that continue to set new records.

China has gone from being the sick man of Asia to the world’s banker and economic driver.

Committed to your PROFITS from China,

Jim Trippon,Â
Editor in Chief 
China Stock Digest

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