Brad Setser: “Power and Financial Interdependence”

New Ifri paper:

The link between financial self-reliance and geopolitical power has long been debated.

The unbalanced Sino-American trade relationship has created asymmetric financial ties which generate potential sources of leverage for both parties and will not quickly disappear. Absent a clarifying major crisis, it will be difficult to definitively determine which party has greater leverage.

Many in the United States (US) are concerned about indebtedness to its primary strategic rival, and the risks posed by a sudden Chinese withdrawal from US financial markets. US policymakers actively sought to encourage China’s top leadership not to withdraw financing from the market for US Agency securities in the run-up to the global financial crisis.

Yet China also sees risks in this unbalanced financial relationship. Chinese policymakers have expressed concern about the domestic political consequences of losses on either their Treasury or Agency holdings and actively have sought to diversify China’s reserves – including by substituting the risk of lending to developing economies for the visibility associated with large holdings of Treasuries in US custodians. China increasingly worries that its dollar holdings and the dollar’s global role increase its vulnerability to potential financial sanctions.

Both parties thus worry about the possibility that financial interdependence can be weaponized yet find it hard to extricate themselves from the inevitability of financial interdependence absent a clean break from an entrenched pattern of trade imbalances.

3 thoughts on “Brad Setser: “Power and Financial Interdependence”

  1. Macroduck

    China’s effort to diversity its reserve holdings doesn’t necessarily have any lmplications for U.S. interest rates past theshort run. If China buys some other asset to avoid holding Treasuries, other accounts sell those assets and need to buy something else to replace them. Everybody swaps assets.

    Portfolio diversification is a good idea ingeneral, so by all means, diversify.

    China diversifying away from Treasuries may not offer much protection from most financial shocks, though, because of the large influence of Treasuries on interest rates, currency rates and portfolio choices across financial markets.

    Financial markets and economies are strongly linked across the globe, and politicians can’t order them to be otherwise.

    1. Ivan

      China is rightfully concerned that a clown like Trump could decide that all those treasuries held by china get declared “nul and void”. Current discussions about Russian assets are not putting them at ease. Those who understand things would say – “oh he would never do that because …..” But you have to remember that he is a moron who do not understand, and cannot be educated. He surrounds himself with advisers who’s only qualifications are knowing how to say “yes Sir, you are brilliant Sir”.

      However, China diversifying into other non-US assets will not have any big influences on much of anything. Maybe our treasuries will give 50-100bp higher yields (unless the feds decide to intervene). Maybe the $ will lose 5-10% value. But unless the whole world decides to get out of $ assets, China swapping itself out is not going to do much harm to us.

      My biggest question about China is how much of all those assets parked abroad will they begin needing to get back home to compensate for the problems in their real estate sector. What happens to their currency if they take a lot of that money back home.

  2. Moses Herzog

    Thanks for putting the gentleman Mr. Setser up Mr. Prof Chinn. Much appreciated. Always new things to be gleaned from Mr. Setser.

    : )

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