China may soon call time on Western quantitative easing. More worryingly, the language she is using is far from friendly.
In a report issued last month, the Dagong Global Credit Rating Company praises "emerging creditor countries" for preventing the collapse of "debtor economies" during the recent crisis, but stresses the "vulnerable position" of America, whose "excess issuance" of dollars has triggered a "global credit war" that "arouses all the countries in the world to take various credit resources as a financial weapon to safeguard the national interests."
Dagong blames QE for increasing exports of capital and raising international commodity prices, causing price and asset inflation in developing countries where, according to a cited World Bank estimate, net capital flows to stockmarkets soared by 42% and to bond markets by 30%.
Signalling that a US Treasury bond sell-off is a "financial weapon" that China may be prepared to use in its defense, Dagong notes that creditor nations stabilised the situation in 2010 not only by "continued buying" of treasury bonds but also because they "continued to hold" them.
China is by far the biggest holder of US Government debt - $891.6 billion at December 2010, according to the US Treasury. This is about the same as a year before, but ignores possible purchases via intermediary nations. In 2009, ex-Roubini associate and now NEC adviser Brad Setser plausibly argued that much of the British buying was on behalf of the Chinese.
This is all the more credible because of the UK government's own deep and long-standing financial troubles: Why would one near-bankrupt lend to another? In December 2010 the ostensible UK holding was $541.3 billion - triple the figure from 12 months earlier. Setser's January 2009 estimate was that taking US Treasuries and Agencies together, China controlled $1.425 trillion-worth.
The UK has since increased "its" stake in Treasuries by over $360 billion, though China appears to have been reducing its exposure to Agencies for some time, according to a July 2009 report from the Congressional Research Service:
Data from the Department of Treasury indicate that in recent months China has sought to reduce its holdings of LT U.S. agency debt, while increasing its holdings of short-term U.S. Treasury securities.
This shift from Agencies to Treasuries, and from long- to shorter-date debt, is itself a subtly troubling trend.
Total Chinese foreign exchange reserves - mostly denominated in dollars, one understands - were $2.45 trillion in June 2010 and the current figure may be over $2.8 trillion. The effect of currency depreciation on its foreign assets is massively expensive to the People's Republic, and it is little wonder that she should be reconsidering her investment - and musing on using her leverage to further other objectives.
Officially, China repudiates the notion of using its foreign exchange reserves as an "atomic weapon", but the use of an ostensibly unconnected agency to convey diplomatic messages would not be out of character. Founded in 1994, Dagong is based in Beijing, and in 2008 its chairman Guan Jianzhong received a "special government allowance" - not merely a monetary prize but a sign of governmental approval.
America still has the world's largest economy, but of developed nations it is also one of the most dependent on refinancing in 2011 - third in GDP terms (27.6%) after Japan and Iceland, and first in absolute terms.
As early as 2007, Brad Setser gave evidence about the US' economic vulnerability to foreign sovereign wealth funds, to the USCC. The US-China "Strategic Economic Dialogues" also began that year and one suspects that some home truths were being told even then. Now the noises are being made more publicly and discordantly, if still at one remove from official sources.
It is getting more serious, and Dagong is not hopeful:
The United States, as the biggest country involved in sovereign debt crisis around the world, will continue its quantitative easing policy when the country is in danger, and the world credit war will be escalated due to the overflow of US dollars.
Clearly we are still at the shot-across-the-bows stage, but we have come a long way from four years ago.