Earlier this month, the failure of politicians in Washington to agree a budget prompted the closure of non-essential government facilities for more than two weeks.
The stand-off only ended at the 11th hour on October 17, when a temporary extension of the debt ceiling was agreed in order to stave off imminent threats of the country’s first ever default.
As well as costing it an estimated $24bn (£14.8bn), the debacle has embarrassed the US as it revealed the extent to which the Republican party was loathe to work with a Democrat president.
Friction was also most evident in the US’s relationship with China, which is the country’s largest creditor as it owns roughly 8 per cent of publicly held US debt.
“As the world’s largest economy, a debt default would not only affect the United States’ reputation, but also drag down the recovery process of the global economy,” China Ministry of Commerce spokesman Shen Danyang cautioned on the official government website.
The country went even further with its rhetoric when Chinese premier Li Keqiang (pictured above) told US secretary of state John Kerry at the Asian summit earlier this month that China had been paying “great attention to the US debt ceiling issue”.
“They are obviously very angry with the US,” Kathleen Brooks, research director at Forex.com said.
She noted that it was “precipitous timing” that the renminbi strengthened to a record high against the dollar during the shutdown, while there had also been recent signs of a liberalisation of Chinese assets which would help further internationalise the renminbi.
These included a currency swap line between the People’s Bank of China and the European Central Bank, and an agreement that British-backed financial institutions could invest up to £8.2bn in Chinese securities, which could help them reel in Chinese investment.
“China will have to look long and hard at what is going on in the US,” Ms Brooks said, to decide whether it still wanted to invest quite so much of its assets there, as the slowdown highlighted that it is a “country with political risk and high debt”.
Rather than diversifying into the euro or sterling, which have been beset by their own problems, the way to deal with this weakness is for the government to allow the Chinese currency to strengthen, the research director argued.
Qinwei Wang, China economist at Capital Economics, agreed that the problem is that Chinese foreign policy seeks to prevent the renminbi from strengthening, while its trade surplus means it needs to invest roughly $20bn each month. “Each month such a big amount of dollars has to be invested somewhere and only the US Treasury market is large enough to absorb that investment,” he said.
“There’s no better options for China, that’s the problem. If China wanted to reduce uncertainty it would have to rethink its policy over the exchange rate, reduce the accumulation of its foreign exchange reserves and rebalance its economy,” Mr Wang added.
But it could be that China has used the world’s depleting sympathy for the US following its debt wrangling for its own gain.
“China takes a very holistic view of its relationship with any other country and we would see that take effect on other areas of the economy,” Frances Hudson, global thematic strategist at Standard Life Investments said. “They are not friends. There is all this tit-for-tat stuff going on all the time but what would have happened with recent events in the US is a publicity game as well,” she said.
“It plays into the media statements and gives China a pretext for slowing down some of the liberalisation measures they [the West] have been calling for.”
Peter Dixon, global equities economist at Commerzbank, suggested the fact that the Chinese had actually increased Treasury purchases during the volatility had been interpreted by some as a conscious move on behalf of the country to take advantage of the situation.
“If you want the conspiracy view, which I don’t necessarily buy, is the more China buys, the more leverage it has over the US in the future,” he said.
However, Mr Dixon added he thinks that in reality this hold may lessen as Western economies become less willing to pass on their skills to Chinese businesses.
“China is treated as if it is an all-conquering super power but in reality it is not as strong as it is made out to be,” Mr Dixon said, suggesting that as Western economies get back on their feet after the global recession, they may reassert their dominance on the world stage.
China’s astonishing economic rise in the past few decades means it cannot be underestimated, while moves to push through reforms including better financial regulation and making its market more investable are likely to see the country increase its dominance.
While the government shutdown in America caused jitters among investors, the US Treasury is still one of the closest things the market has to a risk-free asset.
But America needs to make sure its political squabbling does not severely dent the stability of its debt. Another impasse which takes the country to the brink of a fiscal cliff again could test China’s patience a step too far, potentially prompting it to hit the sell button on US Treasuries and impacting the recovery of the world’s largest economy.
