China worried about US financial position...but not obvious solution

Wen Jiabao, the Chinese premier, is starting to be concerned about the fiscal position of the United States. The New York Times reports:

Speaking at a news conference at the end of the Chinese parliament’s annual session, Mr. Wen said he was “worried” about China’s holdings of Treasury bonds and other debt, and that China was watching United States economic developments closely.

“President Obama and his new government have adopted a series of measures to deal with the financial crisis. We have expectations as to the effects of these measures,” Mr. Wen said. “We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.”

He called on the United States to “maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”

Unfortunately, there isn't a clear solution to this relationship between the two countries:

The Chinese government faces a difficult dilemma. If the United States government borrows less and engages in less fiscal stimulus, this could help prevent interest rates from rising in the United States and would preserve the value of China’s existing bond holdings.

But less government spending in the United States could also mean a slower recovery for the American economy and reduced American demand for Chinese goods. The United States imported 17.4 percent less from China in the first two months of this year compared to the same period last year, contributing to a record drop in Chinese exports that is braking the entire Chinese economy.

The bulk of China’s investment in the United States consists of bonds issued by the Treasury and government-sponsored enterprises and purchased by the State Administration of Foreign Exchange, which is part of the People’s Bank of China.

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Some specialists also say that high inflation could erode the dollar’s value. Finally, some believe that China’s investment in American debt is now so vast that, should it need foreign exchange in some emergency, it would be unable to sell its Treasury securities without flooding the market and driving down their price.

“The only possibility, really, is that China will have to hold these bonds until maturity,” said Shen Minggao, the chief economist at Caijing, a Beijing-based business magazine. “If you start to sell those bonds, the market may collapse.”

A lot of people are blaming America for the crisis but very few seem to realize that they were benefitting from America's current account deficit.

I think America will face some pressure to balance its books. America is in a weakened position right now, partly due to political actions by the Bush administration which will take years to reverse. Internationally, I would say that America has a strong economy and weak political goodwill.