Debt deal needed between US and Asia: ex-PBC member

Korea Times
2011-09-05 00:00
Debt deal needed between US and Asia: ex-PBC member
Converting US bonds into inflation-linked bonds needed to protect Asia’s dollar reserves
By Cho Jin-seo

Yu Yongding, a prominent Chinese economist and a former member of the monetary policy committee of the Chinese central bank, said Asian countries including China and Korea should pursue common interest facing the inflationary monetary policy of the United States.

They may, and should agree on converting nominal U.S. bonds into inflation-linked bonds, and in return China can promise not to ditch Treasury bills dramatically in order to allow the U.S. government to fix its fiscal condition, he said.

Yu’s remark highlights creditor countries’ growing worries on U.S. inflation and its weak economy. It also signals that inflation-linked bonds such as U.S. Treasury inflation-protected securities (TIPS) will receive more attention in the future. Such bonds can give protection to creditors in cases of America’s expansionary monetary policy, such as the so-called Quantitative Easing, which will effectively reduce the real value of ordinary, non-inflation adjusted bonds.

“This is really something we should worry about,” he told Business Focus. “For protection of the value of existing foreign exchange reserves, diversification is one option. But there are other options. For example, China can negotiate with the U.S. whether it’s possible to index these U.S. bonds to inflation.”

Yu said that, for example, if China and U.S. can agree to replace old nominal Treasury bills with TIPS, China will not insist on reducing the holding of U.S. Treasuries. “China will be assured that their holding of U.S. bonds is safe. On the other hand, the Chinese can promise that they will not do anything very dramatic about this foreign exchange reserve -- they will not sell U.S. Treasuries. This will be mutually beneficial.”

Though he is not an official decision maker in the Chinese central bank or in the communist party, Yu’s past position as the academic adviser to the monetary policy committee of the People’s Bank of China gives weight to what he says. His main worry is that his country is losing wealth because much of its foreign exchange reserves are in dollar assets.

Among China’s foreign exchange reserves worth $3.2 trillion, about 70 percent of them are believed to be denominated in dollars. The real value (purchasing power) of these assets has been falling as the U.S. dollar became cheaper compared to other currencies and commodities. Since these debts -- bonds -- are denominated in dollars, the real value of these debts can be reduced if the U.S. government decides to print more dollars to save itself from bankruptcy.

Yu has become one of the most mentioned economists in the world last month, when he wrote to the Financial Times that China should end its managed exchange rate policy and float the yuan, in order to stop the accumulation of its ”excessive” foreign exchange reserve.

He met with Business Focus last Tuesday in Seoul after giving a lecture at the Institute of Global Economics.

Further U.S. downgrade possible

Yu said that the worries about the safety of U.S. government bonds are legitimate, and he and many other Chinese were “not surprised” at all when Standard & Poor’s, a ratings agency, downgraded the Treasury from triple A to double A+.

“I don’t think the downgrading per se has any significant fundamental impact on U.S. Treasury, because we already know it’s not really that safe,” he said. “If the U.S. fails to deal with the deterioration of its fiscal position and if its economy cannot recover strongly, further downgrading is possible.”

Asian economic coalition on U.S. inflation

Yu said that Asian countries such as Japan, Korea, India and Taiwan share common economic interest as big creditors to the U.S., and they need to cooperate in dealing with the risk of severe U.S. inflation. But in reality such teamwork is hard to achieve because of political division in the region, he said.

“We just cannot really help each other. Some of us think that they are facing threat from their neighbours and want to get the the U.S. inolved and to seek (political and military) protection from it. Under this kind of political atmosphere it’s difficult for countries to come together, to put forward common proposals on dealing with the current global financial crisis,” he said. “This is very sad thing for the East Asian countries, but this is reality.”

No more FDI needed in Asia

Yu also attacked the long-standing practice of Asian government officials of welcoming foreign direct investment (FDI). Many local and central governments in the region, including Korea, offer tax holidays, cheap lands and other special favors to foreign investors who do business and build factories. This is “irrational” because these Asian export economies are already running large current account surpluses from trading and there already is enough domestic capital to meet the domestic needs, Yu said.

The result of pro-FDI policies in these countries is that foreign capital is “crowding out” domestic capital in high-return investment opportunities at home, while the homegrown capital is instead invested in low-yield assets overseas. Many central governments have realized this nonsense and China especially is trying to dismantle the preferential policies toward FDI, but at the provincial level, local governments still want to attract FDI for their own benefit, he said.

“So this is not just a problem of economic policy, but is political and administrative. This is more difficult and fundamental,” he said.
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