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Why China Matters to U.S. Investors
U.S. investors are hearing a lot of gloomy predictions about a debt crisis leading to possible recession in the European Union, but there's another region of the world where a slowing economy has the potential to impact the U.S. even more: China.
"Most people don't comprehend how important China is to the U.S., both in terms of trade and in the financial markets," said Sean Snaith, Ph.D., director of the Institute for Economic Competitiveness at the University of Central Florida. Many average investors don't realize they're invested in China, but as Republican candidate Mitt Romney pointed out in the second presidential debate, most company retirement accounts and pensions have some holdings in China.
Although China's economic growth is slowing as part of its effort to control inflation, the repercussions for the U.S. include higher interest rates and potentially lower performance of the stock market.
Interest rates are in danger of rising because China has been buying U.S. Treasuries at a good clip since the U.S. fell into recession. As China's growth slows it won't need to purchase as much, which will lead to higher rates in the U.S. At the same time, the financial markets are threatened because U.S. companies doing business in China will feel the negative impact of its slowing economy.
Up to now, both the U.S. and China have been getting something positive out of China's purchase of Treasuries, Snaith said. "China's middle class is starting to emerge and is dependent upon exports to the U.S.," he said. "If the value of their currency rises, imports become more expensive to the U.S. By buying U.S. debt, China is keeping the value of its currency from rising too quickly."
On the other hand, the same strategy has been good for the recovering U.S. economy because low interest rates have kept the burden of servicing its $16 trillion-plus federal deficit very low. But how long can it last before the U.S. has to face its debt without the aid of China?
"The risk of this co-dependent relationship is that it's not sustainable in the long run," Snaith said. "There's been a lot of talk of a bubble in Treasuries," he added, but well-diversified investors shouldn't panic.
"The global economy has a lot of moving parts, with China decelerating and the European Union moving toward recession like a slow-moving train wreck," he said.
For now, U.S. Treasuries are still the safest bet in a financially uncertain world, Snaith said, but added that the world won't stay uncertain. Eventually, Europe will resolve its debt issues and the U.S. will work toward reducing the deficit. The question is when.
"It could be two years, it could be sooner, but we don't have an unlimited line of credit in the U.S.," Snaith said. The certainty is that eventually, he said, "we will feel the repercussions."