Since China’s accession to the WTO in 2000, the United States and China have formed a highly economically coupling relationship, that has been coined as ChinAmerica. The aggravating trade deficit problem finally evolved into a US-China trade war in 2019 (Figure 1). For more information on the US-China trade war, please refer to my analysis in 2018 (Yiu, 2018a).
According to the economic theory of international trade, when two countries have a long-term unbalanced trade (persistent trade deficit in one country), the currency exchange rates of the two countries should automatically be adjusted. The depreciation of the US dollar would then naturally cause Americans to reduce their purchases of Chinese goods. However, such an automatic adjustment mechanism does not happen due to the unusual coupling relationship. Since the RMB is basically not a freely-tradable currency but is under strong control. The USD-RMB exchange rate can be “stabilized” at such a rate for facilitating more exports. Figure 2 shows the USD-RMB exchange rate since 2000. Unlike other open-market tradable currencies, you can find two straight horizontal lines from 2000 to 2006 and from 2008 to 2011. After the Great Recession, the exchange rate is basically kept between 6.0 and 7.0. The de-facto linked exchange rate between the two is not broken until the end of 2019 when the trade war broke out.
Furthermore, China also buys a lot of US Public Debts to make the exchange rate “stable”. According to the figures in February 2020, China is still the second-largest single creditor country in the United States, holding up to US$ 1,090 billion in US Public debt, accounting for 15% of the total (China has reduced its holdings of U.S. debt since 2011, Figure 3).
The US-China Coupling relationship can be understood easier by a metaphor (See my Youtube: Yiu, 2018b): there is a restaurant that has no guests, so it invites customers to enjoy their food without immediate payment, but allowing very long-term credit at a very low interest rate. The business has soared, but the debt has also increased substantially. Diners are also happy as it becomes “free lunches” especially when they can control the money supply to reduce real debts. (Figure 4)
However, this restaurant recently caused a pandemic due to the sale of wild animals (or other reasons), and infected the diners. The diners are furious and decided not to buy anymore. But with this abrupt decoupling, when free lunches are cut, can US debt continue to sell at the current interest rate? Whether it will lead to interest rate hikes is still unknown.
In China, if export orders plummet, unemployment would skyrocket, the political situation would be unstable, would it cause another crisis is worrying!
Admittedly, both sides have their own allies. The owners of the restaurant could find new customers and the diners can borrow from others. No one would be indispensable. But this will herald a new global cold war that would be evolved as a result of the decoupling between the United States and China. Deglobalization can be expected (Yiu, 2020).
Hong Kong, being China’s main opening for globalization, has already suffered severe setbacks in the re-export trade due to the US-China trade war. Now if the US and China are decoupled, the situation can even be worsened. First, China has heavily relied on Hong Kong as the main window for foreign funds. “According to the Chinese Ministry of Commerce, 66.6% (US$ 89.92 billion) of the total foreign capital in the Mainland in 2018 (US$134.97 billion) was via Hong Kong. According to Refinitv statistics, mainland companies raised US$ 64.2 billion in global IPOs in 2018, and as much as US$ 35 billion was raised through the listing of the Hong Kong Stock Exchange. In 2018, one-third of the US$ 165.9 billion offshore US dollar bonds issued by mainland companies were in Hong Kong. These figures imply the important role of global financing of Hong Kong” (HKEJ Monthly, 2020).
If China loses a large amount of US dollars, it will affect its ability to buy foreign goods, especially because the main currency of global trade and reserves is still the US dollar, and the world ’s largest financial trading system SWIFT (Society for Worldwide Interbank Financial Telecommunications) is also settled in U.S. dollars. It will be difficult to purchase goods internationally without U.S. dollars, and the large amount of U.S. dollar debts currently owed will also be difficult to repay. Would it result in another financial crisis is hard to say!
There have been some recent reports of the digitization of RMB, and has caused speculations of delinking from the western world. Hong Kong currency, however, is directly linked to the US dollar by a currency board arrangement and has long been enjoying the status of a special customs zone guaranteed by the US - Hong Kong Policy Act. Can Hong Kong continue to be a window for China to obtain foreign funds remains to be seen?
Amadeo, K. and Anderson, S.G. (2020) US Debt to China, How Much, Reasons Why, and What If China Sells, Why China Is America’s Biggest Banker, the Balance, Apr 19. https://www.thebalance.com/u-s-debt-to-china-how-much-does-it-own-3306355
HKEJ 信報財經月刊 (2020) 2月號，515期。(In Chinese)
Yiu, C.Y. 姚松炎 (2018a) 美中貿易戰與人民幣匯率，方格子，9月29日。https://vocus.cc/eyanalysispoliecon/5baef0abfd89780001fe0056
Yiu, C.Y. 姚松炎 (2018b) 【EY學堂】中美貿易戰是非戰不可？10分鐘學經濟，Youtube，9月29日。https://www.youtube.com/watch?v=pc74f773Q6Y&t=19s