Timothy Geithner says borrowing more from China to finance tax cuts for the most affluent Americans would be irresponsible.

The Treasury secretary has it backward. The real question is whether Beijing is willing to double down on a nation whose balance sheet makes Italy look good. Holding $1.2 trillion of U.S. debt is a fast-growing risk to China.

Traders have a theory about why the euro is reasonably stable amid a broadening debt crisis: Asian central banks are converting proceeds from recent intervention moves into other currencies. “Asian central banks” has become a euphemism for China, whose reserves now exceed $3 trillion.

China is making deals with nations such as Brazil to conduct trade in yuan. It’s also making noises about the Federal Reserve’s zero interest-rate policies and Congress playing games with the debt limit. If you were managing China’s reserves, how many more dollars would you really want in this environment?

Heck, China is even loading up on Spanish debt these days. “China’s open admission of continual purchases of European debt shows it doesn’t consider the U.S. any safer,” says Simon Grose-Hodge, head of investment strategy for South Asia at LGT Group in Singapore.

The risk that America’s sugar daddy is getting fed up hasn’t escaped U.S. officials. It’s probably no coincidence that Fed officials are talking about dismantling their quantitative-easing program, while Washington is homing in on the deficit.

This enough-is-enough dynamic was on display last week as the leaders of Brazil, Russia, India, China and South Africa, the BRICS economies, met in the Chinese resort city of Sanya. Chinese President Hu Jintao called for reform of our international monetary and financial systems. A commentary by Zheng Xinli may offer a clearer view of what Hu meant.

Zheng, an executive vice president of the China Center for International Economic Exchanges, wrote in China Daily that the “root cause” of the financial crisis was U.S. “long-term abuse” of sovereign credit. He called for the Group of 20 Nations to devise a multicurrency system.

The U.S. takes its AAA credit for granted, knowing that neither Moody’s Investors Service nor Standard & Poor’s has the bravado to downgrade it. Yet we may now be observing the flipside of the 1971 musing by Nixon-era Treasury Secretary John Connally that the dollar is our currency, but your problem. The dollar may soon be Washington’s problem.

The path was set by Geithner’s predecessor, Henry Paulson, who visited China last week. On Paulson’s watch, the U.S. morphed into a huge debt-issuing machine. It has remained in overdrive since, and Asia is getting antsy. What if Moody’s or S&P grew a backbone and took away America’s top rating? What if the dollar crashed?

In recent years, the answer to both questions was Asia; it would always be there come auction time. Until now, this faith made sense. Asia’s reserve arms race since 1997 was about keeping exchange rates competitive and avoiding the humiliation of going to the International Monetary Fund for handouts. The trouble is, it’s a Faustian bargain.

The reference here is to Johann Wolfgang von Goethe’s novel “Faust,” in which an alchemist makes a deal with the devil. He compromises principles for fleeting gains. That, in a nutshell, is where Asia finds itself as the U.S. re-inflates its economy. Asia is kind of trapped.

The trillions of dollars stuffed in U.S. debt could fund infrastructure, education and health care back home. Asia can’t easily withdraw its savings because that would cause a run on U.S. assets, which might put the world’s biggest economy back in crisis. Not knowing what else to do, Asia buys more and more dollars. Ponzi scheme, anyone?

Asia must now decide to continue gambling on U.S. debt or cuts its losses. The $886 billion Japan parked in U.S. debt would come in handy to rebuild its earthquake-devastated northeast. Any sign Japan is drawing down its pot would send shockwaves through markets. Ditto for oil-exporting nations facing people-power revolts.

China, too, is worried about Middle East-style protests, and heading off inflation is vital to taming the masses. Billionaire George Soros last week called Chinese inflation “somewhat out of control.” In March, inflation accelerated to the fastest pace since 2008.

Accumulating dollars exacerbates the problem as it pumps up China’s money supply. Buying fewer would help boost the yuan and give policy makers more control over the economy.

It’s China’s call, though, and that’s a big risk for the U.S. It should worry officials in Washington that speculation Friday about Chinese rate increases had investors rushing into the safety not of dollars, but yen. For some, the risks of quake aftershocks and radiation leaks in Japan seem more manageable than folks playing politics with America’s debt-borrowing ceiling.

As Geithner worries about paying for stimulus, he should remember that it’s not really Washington’s call. The decision will be made by America’s banker 7,000 miles away, and he may be having doubts.

By William Pesek
 
William Pesek is a Bloomberg News columnist. The opinions expressed are his own. ― Ed.

(Bloomberg)