China Power

China and the US Downgrade

Dagong Global Credit Ratings Agency’s decision to downgrade US debt grabbed headlines. Why did it really do it?

The Dagong Global Credit Ratings Agency, China’s answer to Moody’s and Standard and Poor’s, grabbed headlines last week by announcing its second downgrade of US public debt, from AA to A+ with a warning. The new rating places US treasuries below Chinese and German public debt, although still ahead of the United Kingdom and South Korea, citing in a Tuesday press release not only the recent budget fight but a ‘declining trend’ for the United States. The downgrade has been seen in the United States as confirmation of American anxiety about its long-term fiscal position.

Unsurprisingly, it’s no such thing. The move seems to be a mix of indirect Chinese pressure on US monetary policy, tit-for-tat response to a rebuff the company received last year, and a simple, if successful, PR stunt. With US firm S&P concurring, the official Xinhua News Agency has joined the fray, directly criticizing the United States for undermining the value of treasury bonds.

It noted:

‘Dagong Global, a fledgling Chinese rating agency, degraded the US bonds late last year, yet its move was met then with a sense of arrogance and cynicism from some Western commentators. Now S&P has proved what its Chinese counterpart has done is nothing but telling the global investors the ugly truth.

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‘China, the largest creditor of the world’s sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China’s dollar assets.’

The Chinese government has good reasons to care about the strength of American bonds – but fears about repayment aren’t among them. Rather, China is effectively demanding that the United States implement industrial policy on its behalf: by selling more and more treasury bonds, the US government has made it more expensive for China to maintain the strong dollar-renminbi exchange rate it has used for decades to subsidize Chinese exporters. 

In order to make Chinese exports competitive, China has for decades been buying US dollars at a renminbi price most analysts consider overvalued – without government intervention, most say, it would be impossible to find someone willing to pay more than 4 RMB for a US dollar. So, as more dollars are released into the market in an effort to stimulate the American economy, Beijing will be forced either to buy a large portion of them at this inflated rate or to accept an exchange rate less favourable to Chinese exports.

Thus, it’s not surprising Dagong cited US monetary policy in its brief downgrade statement, referring to largely uncontroversial ‘quantitative easing’ – a policy recently pursued by the Federal Reserve and several European banks, which increases the supply of dollars – in apocalyptic terms. ‘It is natural that QE3 monetary policy will be enabled for the next step, which will throw the world economy into an overall crisis,’ they wrote. Monetary policy, which is funded by the Federal Reserve, has no direct implications for the Federal budget; if anything, expansionary policy like easing should reduce the burden of the debt.

So what is Dagong’s connection to China’s national bankers? The Wall Street Journal’s China Real Time blog observed close connections between the ratings firm and the Ministry of Commerce last year, when it was refused certification by the US Securities and Exchange Committee. It quickly fired back, accusing the SEC of discriminating against China and attempting to violate Chinese sovereignty.

The firm changed business tactics following the rejection, issuing its first downgrade (PDF download) a month later in language clearly aimed at Chinese politicians rather than international financiers. The lengthy statement complains of the ‘US global hegemonic strategy’ and ultimately concludes that ‘the occurrence and development process of the credit crisis in the US resulted from the long-standing accumulation of the contradictions in its economic system.’

Underlying both downgrade statements, Dagong seems to rely on the widespread belief among Chinese policymakers that the United States is in a period of ‘late imperial’ decline. It’s surprising to see that a Chinese company talking the quaint language of dialectical materialism can gain traction in an American policy debate, but it points to a lesson many Chinese commentators have learned – playing to US anxiety about decline gets an appreciative audience in Washington as well as Beijing.