America’s secret deal with China

The US and China have a relationship that is unlike any other in the world. One is the preeminent superpower and the other is aspiring to be one. They are extremely wary but pragmatic rivals. And they have entered into a secret deal to help one another.

China has $3.3 trillion of reserves in its coffers, the biggest in the world, and it is the US’ biggest creditor. And its reserves continue to grow, albeit at a slower pace in recent months.

So what does the US do? It enters into a secret understanding with China, giving it privileged status as its biggest financier. The US Treasury department has allowed China direct access to its bond auction counter, helping in reducing its transaction costs and bypassing Wall Street to buy bonds but not sell, Reuters reported Monday. The deal helps China to command better rates.The arrangement has been in place since June 2011.

It clearly demonstrates that for the US, national interest is paramount and it will do unconventional deals to protect them. Former diplomat MK Bhadrakumar has an interesting analysis of the secret deal here. And here is another view by Prof Daniel Drezner of Fletcher School.

Can European Union have done a similar deal? China could have been the lender of last resort for Europe. An outside financier would help the beleagured nations of the Eurozone greatly and reduce their dependence on Germany, whose prescriptive attitude is hard for others to stomach. In fact, a couple of months ago at the BRICS summit in New Delhi, China had said that it was willing to fund a European rescue effort. A deal is yet to be announced though.

May 25, 2012 17:52 pm by Sri Hari

Commented on America's secret deal with China

Dinesh, Let us forget what Reuters reports, look at the facts. In the name of reforms of the financial system underwriting rules were relaxed, documentation of loans were minimal, resulting in a criminogenic environment. The financial products sold were primarily 'cash-for-trash' or 'liars-loans', and this was across all asset classes. Betting on this products through CDS's and synthetic CDS's compounded the situation. Perhaps 'Volcker Rule' should have been strictly enforced. Adding to this the US Feds had a very contractionary monetary policy when the banks were re-capitalised and interest was paid by Feds for the loans. The combined debt overhang of US & Europe is around $15-20 trillion dollars. The trade surplus that China has acquired is this debt -recycled and not something China created. So how will a paltry $3 trillion help in this situation?? Probably the Chinese need that to re-capitalise Chinese banks, to save them from the NPAs. The solution could be found if- majority of debt were converted to equity by the creditors and then they (creditors) take a haircut, strict underwriting rules were re-instated, higher level of equity is made mandatory for financial institutions to survive any shock and executive compensation is based on return on total capital employed. US Feds need to target a higher nominal GDP growth and the market needs to be sure the monetary base will remain place even if inflation picks-up, if the nominal GDP is at around 4-5%.

May 25, 2012 10:24 am by Dinesh Narayanan

Dear Sri Hari, The Reuters story says the deal is only for US treasury bonds, not corporate bonds. Please see the link to the original Reuters story that gives the details. Of course, government bond rates have a bearing on the debt market as a whole. Also I am not suggesting that China alone can rescue Eurozone. But Europe sure can use any amount of money it can get and China is one option. Actually the one option which has a lot of money to spare. And talks are indeed going on as the Chinese representative said in Delhi in March. And here is a link to a BBC story in February http://www.bbc.co.uk/news/world-asia-17022756 Dinesh

May 25, 2012 09:32 am by Sri Hari

What a load of bunkum!! All that the US Feds try to do is to increase or decrease the monetary base and not M2 money supply. M2 is beyond the total control of sovereign nations. 3 trillion dollars sounds a lot, but a small amount if you compare it to the corporate bond market. Are you suggesting the Chinese or the US Central Bank can influence the corporate bond market...Absolute nonsense...you have little idea of global finance... China rescuing the Eurozone????...Forbes, please refrain from publishing such articles...

May 25, 2012 07:35 am by Vikram Singh

It's only a matter of time before US realizes it's mistake. Placing all your eggs in one basket is not an intelligent decision. Chinese juggernaut is slowing as it's young working class is fast declining. Soon China will need external credit to keep it's economy moving. Albeit it's world's fastest growing economy but the unequal economic growth amongst it's sections will fuel unrest. US will have to learn the hard truth that one can't spend more than one earns. Alas! It's self proclaimed authority of world policing requires huge money that can only be funded by dollars. Americans have got limit to fund it's geo-political war machine by taxing it's own citizens. So they have no other option but to print more dollars. And no other nation other than China is going to park it's income in this show. German model of growth and prosperity is the most stable and secure. It's in the long term interest of Europe to show faith in Deutsche land and follow austerity.

Dinesh Narayanan

May 24, 2012 14:24 pm by Dinesh Narayanan

Dear Kalyan, Thanks for pointing out the mistake. It is $3.3 trillion not billion