As America’s largest foreign creditor, China has little option but to hope for the best and try to calm jittery markets in the event of a downgrade of US debt by the ratings agencies according to economists at Capital Economics.
“China’s hands are tied for as long as the People’s Bank (PBC) continues to intervene on a large scale to prevent renminbi appreciation,” said Mark Williams, the senior China economist at Capital Economics in a research note.
“Whatever misgivings it may have, China cannot sensibly avoid investing in the US Treasury market if it continues to accumulate reserves on this scale,” he added.
With China holding anywhere between a quarter and a third of all US debt, it finds itself caught between a rock and a hard place.
Sell the Treasurys and Beijing risks undermining the value of its other holdings.
“A downgrade on its own would not justify China rethinking its investment strategy,” said Williams.
Even if the US was downgraded, it would still have a higher rating than China, and with Japan already rated AA and the euro zone struggling with its own debt crisis Williams thinks a rise in US yields could be a buying opportunity for the Chinese.
“If yields did spike, then China as a long-term investor may see an opportunity to buy,” he wrote.
Higher yields would of course mean more US tax dollars being handed directly to China each year to meet interest payments, but the Chinese will want to avoid a damaging US default, according to Williams.
“China would probably seek to calm markets rather than risk startling them with a policy change. Just as Chinese officials have pledged to continue buying euro zone debt at various points recently, China is likely to react by emphasizing that the PBC will continue to buy Treasurys,” said Williams.