When a giant is about to fall, you should give him certain support to help him to fall down slowly instead of his falling down all of a sudden, or you would be the one who suffers. That's why I said "China should coordinate the gradual fall of the U.S." instead of allowing her to collapse all at once.

Sohu Business: After S&P downgraded the credit rating of U.S. treasury bonds, the over $1 trillion U.S. treasury bonds held by China became the prime concern of our people. Will the U.S.–Teasury-Bond Crisis affect the security of China's foreign exchange reserve? 

Sheng Hong: Surely it will, but not seriously. The effects would be in the form of so-called "assets depraciation." Through raising the debt ceiling, the U.S. actually meant to perform its obligation of paying debts in the manner of "rolling over old debts with new borrowing," which was in fact an act of bankruptcy from a business perspective. It's only because the U.S. is a special country that it can use this manner. In reality, the credit of U.S. treasury bonds has already been seriously damaged.
 
If the U.S. wants to borrow again, it must pay more costs. Because its credit rating has been downgraded, it has to pay more interests to make up for this part of risks. Meanwhile, the old U.S. debts are also devalued because of their low interest rates. That's why the U.S. treasury bonds held by China are impaired. However, the devaluation does not mean that these assets are not worth a penny. This is impossible. Although the credit rating of U.S. was degraded, the U.S. is still credible, even the most credible one throughout the world.
 
In the long term, the U.S. is heading towards decline and will become weaker and weaker. However, the so-called "weak" is a comparative word. In comparison with China, the U.S. is still very strong. The U.S. is going down from the summit, whereas China's is climbing up from below.
 
Sohu Business: That is to say, we do not need to worry about the overall safety of China's foreign exchange reserve over a period of time?

Sheng Hong: Yes, but we still need to be constantly alert. In the long run, the U.S. dollar will gradually weaken and a crash of the currency is possible when it weakens to a certain extent. This is because, one way to solve the U.S. debt problem is to borrow, and another important way is to increase the supply of dollars, which will further weaken the U.S. dollar.
 
If people lose faith in the U.S. dollar and anticipate the U.S. government to continue the inflation policy, they will sell dollars and aggravate the crash of the currency. This, however, will not happen at once. Moreover, the U.S. government is rather cautious at present. Although it is inclined to a loose monetary policy, including the quantitative easing monetary policy, thus increasing the amount of U.S. dollars, which made up the U.S. fiscal deficit, fiscal problems will soon be reflected in its currency. Therefore, in terms of interests, China must be very careful though this problem will not happen right now and that the U.S. dollar is still stronger than the RMB now; in terms of strategies, China should pay more attention to and begin to make preparations for it. Or it would be too late to prepare when that day comes.

For another, we should gradually cut down on our holdings of U.S. treasury bonds. Surely, this is a long-term process because China can not sell U.S. dollars right away. Once China sells dollars, the U.S. treasury bonds will plummet because China is the largest holder and client. Since selling is a signal, we would actually be tied down. Therefore, the first thing we should do is to reduce the increment, or at least slow down the pace of increment increase.
 
China should not intentionally pursue trade surplus with the U.S. as well as with many other countries. China should place its focus on trade balance.
 
Sohu Business: After the U.S. debt ceiling was raised, would the U.S. raise the ceiling again if it fails to solve these problems?  [Page]

Sheng Hong: This is not a new problem, but an old one. This problem has existed since the 1970s. James Buchanan, a renowned economist, had many discussions on the U.S. fiscal problems. His suggestion was that the U.S. should carry out a constitutional reform and formulate a provision in the Constitution which requires fiscal balance with no deficits. These requirements, however, were actually broken through repeatedly. Why? Because there's a profound mechanism behind this, that is, the common people dislike economic recession. Nevertheless, normal economic cycles surely have economic recessions, which is the most basic logic. Let's take another instance. The common people like spring, summer, and autumn, and dislike winter, but none of them is capable of getting rid of winter. The current governments, however, are capable of getting rid of the "winter of economy" by conducting expansionary policies during economic recessions. This is Keynesianism.
 
When "winter of economy" comes, fiscal expansion would be carried out. Fiscal expansion requires borrowing, and then there would be deficits. This is a one-way process. It's exactly this sort of expansion which leads to the next crisis. The 2007 Subprime Lending Crisis was exactly the consequence of expansion. 
 
During recessions, governments both conduct public projects by themselves and encourage consumer credit. However, when consumer credit is encouraged to the full extent and the credit market of financially qualified consumers is saturated, subprime lending would occur. Consumer credit has been carried out in the U.S. for several decades after World WarⅡ, and it develops at a very fast rate. In the end, after all the people who had borrowing and repayment capabilities had all borrowed and repaid money, those who had no repayment capability were also attracted in so as to stimulate economic growth. However, these people would default their loans even when the slightest economic fluctuations and contraction occur. Banks would go bankrupt when there are two many defaults. The logic is like this.

The consequence of expansion is crisis, and expansion will be carried out again when crisis occurs. This is a vicious cycle. What's most important is that there seem no solutions behind this mechanism unless that the common people are calm enough to spend less when recessions come. Nevertheless, nobody feels like doing so, and it is the same with the Europeans. Everybody came out to protest when there's economic contraction in Greece. Modern people can only accept economic growth and new highs of annual income. They could hardly accept lower or even the same salaries with the previous year. This is really troublesome. That's why the directions of debts could not be changed.
 
Sohu Business: Japan once was the largest holder of U.S. treasury bonds, and then China caught up from behind and outstripped Japan. During this process, did Japan take the initiative in reducing its holdings of U.S. treasury bonds? Does it have some good methods in this aspect which China can learn from? [Page]

Sheng Hong: I do not think so. In fact, Japan's holdings of U.S. treasury bonds were surpassed by that of China mainly because China's trade surplus grew too fast. According to the logical relationship with the U.S., those who have big trade surpluses with the U.S. would inevitably purchase more U.S. treasury bonds. This does not indicate how clever Japan was. Pressure from the U.S. is another important factor. The U.S. has been talking about what should be done about the huge trade surplus with the U.S., and it hoped the RMB and Japanese Yen to rise. If negotiations can not work, the U.S. would require these countries to purchase its treasury bonds. Therefore, there’s pressure behind it. Japan faced more pressure from the U.S. than China did because Japan depended on the U.S. politically. Sometimes, Japan purchased U.S. treasury bonds not because it wished to but because of political pressure. The U.S. said, since you rely on me, you must support me; if problems and crisis happen to the U.S. finance and government, it will not do you any good; we are one interest community, and you are doomed if you do not help me. Now it's the same case with China. If China does not help the U.S. and wants to sell U.S. treasury bonds, China would be finished because the unsold treasury bonds would be impaired.

Sohu Business: This vicious cycle would not be broken for a certain period of time. However, people would try to think of other ways.
 
Sheng Hong: You could sell little by little. But you have over $1 trillion, whom you can sell these treasury bonds to? This transaction is transparent in the world. Even if you sell only 100 dollars, it would be an important piece of news. The key does not lie in how much you sell but in who sells. It's very hard for China to escape without being noticed. Therefore, I believe the most strategic measure is to reduce the increment of trade surplus. 

We can not sell the existing U.S. treasury bonds, but we can choose to reduce our holdings slowly. Nevertheless, I doubt how much strategic significance this action has. Probably no strategic significance could be seen at all. That's why a more strategic choice is to reduce the increment of trade surplus. Even if the U.S. is declining, we should not allow it to collapse all at once. This is like, when a giant is about to fall, you should give him certain support to help him to fall down slowly instead of his falling down all of a sudden, or you would be the one who suffers. That's why I said "China should coordinate the gradual fall of the U.S." instead of allowing her to collapse all at once.
 
Sohu Business: A large number of Chinese enterprises are export-oriented. If China adopts the strategy of gradually reducing trade surplus, what effects would be exerted on them?
 
Sheng Hong: These enterprises are actually part of China. They have their own interests, but they are only an interest group rather than the whole of China. Sometimes, the interests of Chinese exporting enterprises were exaggerated as the interests of China. This is a problem. In terms of China's policies and strategies, the interests of these enterprises have to be subordinated to the overall interests of China. This is the first point.  [Page]

The second point is, though these enterprises seem to insist that it's beneficial for them if the RMB does not appreciate, it's actually not beneficial for them in the long run. If the RMB does not appreciate, the increased trade surplus will lead to large quantities of money supply and cause inflation in China. Then costs of these enterprises will rise. The only difference is that this process is indirect. We need to understand this truth. Though certain individual enterprises would underestimate this by supposing that inflation is not caused by them, trade surplus caused by the interests of the trade interest group would lead to the increase of inflation macroscopically. If we reduce trade surplus, we also reduce domestic inflation pressure, which won't harm the interests of these enterprises much. We should be clear about this point.
 
Besides, from Japan's experiences it can be seen that the appreciation of one country's currency does not usually reduce export significantly but increases import significantly. That's why trade surplus declines. Judging from this point, the appreciation of one country's currency is not fatal to its exporting enterprises. Their profits definitely would be affected, but this is not fatal to them and they will be able to survive. From this sense, it's beneficial for the whole country if we adopt such a strategy, and it’s not as bad as imagined for these interest groups.
 
Facing the crisis, we should accelerate the appreciation of RMB exchange rate so as to reduce trade surplus and the inflation pressure. At present, the major problem faced by China is the inflation pressure. There's a high inflation pressure of 8% before the 2008 Financial Crisis. That's why I said that the financial crisis saved China. The so-called crisis led to less export from China to the U.S. For us, this means less trade surplus and less money supply. At that time, the attention of most people was placed on the bankruptcy of enterprises. In my opinion, this is an overestimation of the seriousness of the situation which then led to the excessively forceful macro policies. 

Sohu Business: What other aspects of China would be significantly affected by the U.S. Debt Crisis?
 
Sheng Hong: The most direct effect is that we need to draw a lesson. Regarding the long-term strategy, China should not head towards the U.S. Model. Although the U.S. Model would remain beneficial to the U.S. for quite a long period of time, there’re still problems with this model in general. China does no lighter than the western countries in stimulating economy and avoiding economic recessions. The problem is, China is more fragile and more serious crisis might occur in the future. We should thoroughly analyze, study and summarize these problems, put forward theories and make certain adjustments. This is, however, only a theory. What measures the government will actually take is determined by the current political structure. China should draw lessons on how to prevent problems from getting worse. We should moderate our measures rather than overexerting ourselves whenever we implement a policy. Economic fluctuations should be gentle. Our policies, however, would enlarge the fluctuation ranges. [Page]
 
Politicians are often short-sighted, caring about only the present rather than the future. Regrettably, this is the case both in China and the U.S. Only a politician who can transcend politics will be able to see through this problem. Besides, it won't work if he is not powerful enough because he won’t be capable of affecting governmental policies.

Sohu Business: Some people believe that the degrading of the credit rating of U.S. debts might be a turning point of the U.S. which signifies the U.S. is about to go from strong to weak. What's your opinion? 
 
Sheng Hong: In fact, the turning point came out long ago. Moreover, I have mentioned in my articles published previously that the turning out was actually the financial crisis which occurred at the end of 2007 and the beginning of 2008. Now, it's just that some people attached labels to current events, before which many people did not even know about the situation. Nevertheless, economists should start their analysis from the financial crisis. I mentioned in my article titled Who Would Let Obama Stand Alone? that Americans could not blame others for questioning the safety of the U.S. assets since they caused the financial crisis by themselves. I won't buy your financial assets if I do not trust their safety. If you want me to buy your financial assets, you must offer higher returns. When you lose others' trust in you, you are already going down from the peak.
 
The 9/11 Attacks struck the U.S. seriously, but not as seriously as the Financial Crisis did. The Financial Crisis was inherent rather than extrinsic. I have been following this issue ever since the financial crisis. I said at that time that the U.S. would gradually head towards decline. The debt crisis happened because not so much seigniorage could be collected any more. The U.S. has inertia in foreign military contacts which prevents it from withdrawing its troops from Afghanistan and Iraq at once, and it had to cope with the financial crisis. Therefore, the debt crisis is inevitable. It is not a turning point but a label attached by S & P.
 
Sohu Business: That is to say, this event is merely a phenomenon occurred during the turning process of the U.S., and it is an inevitable phenomenon. Apart from debts, what other aspects of the U.S. will similar situations happen to?

Sheng Hong: The military contraction. This is very important. After Obama came to power, he clearly sensed that the military existence by the U.S. throughout the world could not remain the same as before because the U.S. has less and less money. The reality of the U.S. faced by Obama is an inevitable continuous contraction, which is actually a strategic turning point of great significance for the U.S. I mentioned just now that when trade deficits are reduced, less reflux of dollars will be attracted, resources of military expenditure will be reduced, and then military forces should be contracted. 

August 11th, 2011