As the relentless ticking of the clock counts down toward a potentially unprecedented US debt default, the world's second and third largest economies, China and Japan, watch with mounting trepidation. With a collective investment of $2 trillion, representing over a quarter of the $7.6 trillion in U.S.
Treasury securities held by foreign countries, these Asian economic powerhouses are the leading foreign investors in US government debt. Historically, Beijing began escalating its purchases of US government bonds in 2000.
The United States' backing of China's entry into the World Trade Organization sparked an export boom, generating a colossal influx of dollars for China, which necessitated a safe storage solution. US government bonds, seen as one of the world's most secure investments, provided a sturdy safety net.
China's holdings of US debt swelled from $101 billion to an impressive $1.3 trillion by 2013. Although China has been the largest foreign creditor to the United States for over a decade, increasing tensions with the Trump administration in 2019 led Beijing to scale back its holdings.
Japan seized this opportunity to surpass China as the primary creditor that year. With Japan holding $1.1 trillion and China with $870 billion, their heavy exposure leaves both countries susceptible to a potential decline in the value of U.S.
Treasuries if Washington's debt default transpires.
Potential Economic Repercussions and Mitigating Strategies
A devaluation of government bonds could precipitate a fall in the foreign exchange reserves of both Japan and China, effectively diminishing their ability to pay for essential imports, service their own foreign debts, or shore up their national currencies.
Experts, however, point out that the "real risk" lies in a global economic downturn and a probable US recession following a default. While China's economy has been stumbling amid slowing consumption, investment, and industrial production since the abrupt lift of pandemic restrictions, Japan's economy exhibits signs of shrugging off decades-long stagnation and deflation.
Notably, China and Japan rely heavily on the world's largest economy to bolster their domestic companies and employment. China's export sector remains paramount, particularly in light of faltering sectors like real estate.
Remarkably, exports contribute a fifth to China's GDP, providing employment for an estimated 180 million people. Despite geopolitical strains, the United States continues to be China's most significant trading partner and Japan's second largest, with US-China trade reaching a record level of $691 billion in 2022 and Japan's exports to America expected to grow by 10 percent.
World Leaders Express Concern
The potential US debt default has elicited mixed reactions from world leaders. The Bank of Japan's Governor, Kazuo Ueda, voiced concern last Friday, warning of the potentially catastrophic consequences for the global economy.
Conversely, Beijing remains relatively reticent, with the State Department expressing hopes for the US to "adopt responsible fiscal and monetary policies" and avoid transferring risks to the global platform. Reflecting on the global economic entanglement, China's state-run Xinhua news agency emphasized the "symbiotic relationship" nations share with the US bond market, underlining the crucial role it plays in maintaining international economic stability.
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