Biggest U.S. foreign creditors show concern on default risk

China and Japan, which together hold more than $2.4 trillion in U.S. Treasuries, raised pressure on the U.S. to resolve a political impasse on its debt ceiling that threatens to destabilize global financial markets.

Japan must consider the impact of any default on its bond holdings, even as the U.S. will probably avoid a fiscal crisis, Japanese Finance Minister Taro Aso said today in Tokyo. Chinese Deputy Finance Minister Zhu Guangyao said yesterday that the U.S. should prevent a default, the People’s Daily reported.

Any failure by the U.S. to honor its debt obligations would damage the dollar’s status as the world’s reserve currency. A shift in asset allocation by China, Japan or other major holders of Treasuries could push up U.S. interest rates and cause swings in global currency markets.

“If a default on U.S. debt occurs, there will be a huge impact on markets,” said Yuichi Kodama, chief economist at Meiji Yasuda Life Insurance Co. in Tokyo. “In the long run, some nations could review the allocation of their foreign reserves and shift to a better-balanced portfolio.”

The warnings are being made days before finance ministers and central bankers convene in Washington for the annual meetings of the International Monetary Fund and the World Bank. The IMF said today a U.S. default could “seriously damage the global economy.”

Treasury Owners

China, the largest foreign owner of U.S. Treasuries, had $1.28 trillion worth at the end of July, followed by Japan, which held $1.14 trillion, according to the U.S. Treasury Department. China overtook Japan as the largest foreign owner of Treasuries in September 2008, with the value of its holdings surging 107% since then. Japan’s rose 84% over the same period.

“Japan must be aware that the absolute value of those debt holdings would decline” should the U.S. default, Aso said at a press conference. Nations such Japan and China that have a large proportion of dollar-denominated reserves need to think about this, he said.

“If the debt ceiling problem worsens, it would affect the world economy,” Aso said, adding “we hope this problem will be resolved without delay.”

Germany also hopes the effect of the U.S. government shutdown will be temporary and that its debt won’t be downgraded, a government official told reporters in Berlin today.

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