The fate of the U.S. dollar, the U.S. economy, and climate change

One of the unique aspects of the current economic crisis is that it began in rich countries (particularly in the U.S., U.K., Spain and Iceland property markets) and the result is many developing countries are nervously observing the developed countries run up massive public debts and nationalize companies that are near bankruptcy. Remember that just over ten years ago, developed countries were telling developing countries to enact structural reforms like reducing public debt and allowing companies to fail in order to end the ill effects of the Asian Financial Crisis.

Now China holds somewhere around $1.7 trillion in American debt. In other words, every American owes China about $5,000, which is well above the average annual income in China. China is telling the United States how to handle its economic affairs and is worried about escalating public debt. Chinese PM Wen Jiabao expressed concern about how America’s low savings and high debt will affect the value of China’s holdings in Treasury bills. “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.”

Interest rates will certainly fall if (when) the U.S. issues billions (trillions) more in Treasury paper, and China cannot sell its holdings because selling such a large amount of bonds would cause their value to collapse.

Chinese officials are also searching for a new system for central banks to use to store currency reserves, instead of the situation today where reserves in central banks around the world consist almost entirely of U.S. dollars. Possible alternatives are a basket of currencies or by reviving the IMF’s Special Drawing Rights, which is a unit of accounting that was created in the 1970s to also serve as a central bank-only reserve currency.

The two country’s economies are now inextricably linked – the world’s largest consumer (the U.S. is about ¼ of the world economy, and 70% of it is consumer spending, so that’s a big chunk of the world economy) and the world’s largest lender, the largest holder of foreign reserves, and the second largest exporter (China just surpassed Japan in American debt holdings, has $2 trillion in foreign reserves, and is second behind Germany in total exports). The historian Niall Ferguson describes the new world order as a global economy dominated by “Chimerica,” which played a central role in the real estate bubble in the United States. (See Andy Xie on other ways the two economies are closely linked. Michael Meyer on China’s traditional urban planning around hutong’s is also worth checking out.)

Some of the vast differences between the two countries could also provide opportunities for cooperation in productive ways (other than the previous cooperation of selling cheap goods to the U.S. for U.S. dollars and then using the dollars to buy T-bills so that interest rates stayed low and Americans could buy more cheap goods, which gets recycled into more T-bills…)

Over 70% of U.S. carbon emissions come from consumer-related activities, whereas more than 70% of China’s carbon emissions come from industry. We can learn from their use of bikes, buses, trains, solar water heaters, and dense urban living, while China could adopt our cleaner power plants, more efficient industrial processes, and service-based economy. At the government level, cooperation between China and the United States is critical for the next international climate change talks in Copenhagen.