China sends warning on US debt, dollar

The debate over whether to keep borrowing trillions of dollars may have been mooted on Friday.  China sent out strong signals at the end of last week that it would retreat from the dollar and perhaps start to unload its reserves sooner rather than later (via Instapundit):

China should reduce its excessive foreign exchange reserves and further diversify its holdings, Tang Shuangning, chairman of China Everbright Group, said on Saturday.

The amount of foreign exchange reserves should be restricted to between 800 billion to 1.3 trillion U.S. dollars, Tang told a forum in Beijing, saying that the current reserve amount is too high.

China’s foreign exchange reserves increased by 197.4 billion U.S. dollars in the first three months of this year to 3.04 trillion U.S. dollars by the end of March.

Tang’s remarks echoed the stance of Zhou Xiaochuan, governor of China’s central bank, who said on Monday that China’s foreign exchange reserves “exceed our reasonable requirement” and that the government should upgrade and diversify its foreign exchange management using the excessive reserves.

Meanwhile, Xia Bin, a member of the monetary policy committee of the central bank, said on Tuesday that 1 trillion U.S. dollars would be sufficient. He added that China should invest its foreign exchange reserves more strategically, using them to acquire resources and technology needed for the real economy.

That report comes from, the official news agency of the Chinese government.  It’s Beijing’s megaphone, which means that the opinions expressed in the report most likely does represent that of management. Right now, that opinion in Beijing appears to be that they have three times as much in dollar reserves as they actually need.

China won’t dump the dollar any time soon.  They need the value of the dollar to remain strong to protect the reserves they already own.  The collapse of their high-speed rail bubble means they can’t afford to go to economic war with the US at the moment, assuming that they were inclined to do so at any time.  It does mean, however, that Treasury will have to work much harder to sell its bonds, which will force yields up and increase the debt service, and may mean that we won’t find many buyers at all.  If China stops buying, the next best customer is Japan, which won’t be able to afford more bonds for years; in fact, they may have to sell theirs to fund their recovery efforts from the quakes and tsunamis of 2011.

Who else will come to our rescue?  The Saudis?  Don’t bet on it.

We are rapidly approaching a moment of truth.  While we debate the finer points of raising debt limits and calculating just how many hundreds of billions of dollars in annual deficits we’ll tolerate, the truth is that the money to fund any deficit spending may soon run out.  Fiscal sanity may wind up being imposed on us if we don’t choose that path willingly.