It’s almost impossible to mention China in a conversation now without hearing about them owning a large portion of our debt. Based on my own unscientific and anecdotal perception (I asked a bunch of people), most would answer that China owns “most” or “close to half” of our debt, and I’m commonly asked “when I think that Mao Zedong will be on the hundred dollar bill.”Before we begin, I’d like to make clear that I am a fiscal conservative. I believe the US should not routinely run a deficit, particularly a large one. I live in a state (Florida) with a balanced budget provision in our constitution and even though it’s ignored from time to time, I think it would be a good thing to have nationally, and I believe it to be extremely unwise to routinely run deficit spending.
One of the best resources for understanding the national debt is, unsurprisingly, the US Treasury. You can read up to date reports on outstanding debt and its holders here. Wikipedia has a slightly outdated but directionally graphical correct representation of this data here. From this, we can see that somewhere around 30% of all US Treasuries are held by foreign and international interests. The rest are held by insurance companies, other investors, pension funds, mutual funds, and the government itself (mostly the Social Security trust fund).Already, this is probably not the picture you expected. Less than a third of all US debt held by foreigners. The treasury helpfully breaks this down further here, listing each country by holdings and the dates of the holdings. Of that debt, China is indeed the leading holder at roughly 20.8% (as of July 2010), but Japan is right behind at 20.2%, then the United Kingdom at 9.2%, then oil exporters (5.5%), Brazil (4.0%), Hong Kong (3.3%), Russia (3.2%), and Republic of China or Taiwan at 3.2%.
After just a few minutes of basic research, we’ve learned that China has roughly 6% of our national debt under its ownership, and of the rest of the countries on that list, Japan, the UK, Taiwan, and Brazil would be counted in the friendly-to-America column, or at least in the “choose America over China” column. It can be argued that Hong Kong is essentially China, but it still doesn’t change the general picture at all.China, along with other countries, just doesn’t own that much of America’s national debt. In fact, I’d say in light of all the political rhetoric, 6% is a shockingly small amount.
Still, lets say that the nightmare scenario happens, things went sour with China, and they wanted to begin flexing their muscle, using our debt against us as a weapon. What would their options be?
- They could sell their holdings. This would immediately depress the value of treasuries and probably cause some amount of alarm. However, were China to begin selling their nearly 800 billion in treasury bills, the market for these bills would rapidly cause their existing holdings to plunge in value. In other words, by selling, they’d screw themselves fairly quickly, and they’d be forced to take that money and place it somewhere else. Where? The EU has proven recently to be a less than stellar investment. Their own domestic market wouldn’t be able to absorb a nearly trillion dollar capital injection without being inflationary. Not to mention that the Fed could simply step in like they did with TARP and buy up the 800 billion dollars that China would sell, at rock bottom prices. Our allies could also mobilize considerable buying pressure so that their own holdings wouldn’t devalue. At the end of it all, China would probably lose the most from this maneuver.
- They could unpeg their currency to the US Dollar. China today artificially keeps their currency pegged at an unfavorable exchange rate (to them) in order for their products to remain cheaper for Americans. Unbelievably, most of the current US diplomatic effort on economic issues is centered around trying to get China to remove this peg, thus making things more expensive for Americans. Derogatory terms like “dumping” are used to describe China’s gift of subsidized products to millions of Americans. By demanding that China unpeg its currency, we’re basically saying “remove your artificial subsidy on goods that middle and lower class Americans predominantly buy, and that will help us.” Smarter people than I have written on this elsewhere numerous times.
- Are there other options here? I’m trying to think of them, but the reality is this – Chinese businesses are flush with dollars. There’s a reason almost all of the countries that are major holders of US debt are manufacturing or commodities export driven (China, Taiwan, Brazil, Oil Nations, and Japan). They receive dollars for their products, and need to buy materials to make their products. These materials can and do often come from other economies, so it’s advantageous to use the world’s reserve currency to procure these materials. Notice how India is absent from the list – they’re a knowledge exporter (mostly services and knowledge work like software), and therefore most of their income is paid in wages to individuals who then spend the cash within their own economy, not paid to other economies to procure raw materials.
If you were to obtain a large sum of money (in the billions or trillions of dollars), you’re going to need to make decisions regarding the investment of that money using long term, macro-level criterion. Government stability comes into play, geopolitics becomes important, and all of a sudden in addition to a rate of return, you’re faced with the difficult decision of who do you trust with your money – but on a national scale. If you’re China and you’re looking around the world to invest your US dollars, you can choose Europe, a handful of economies in SouthEast Asia that are just as invested in the US as you and are competitors to yourself, Africa, or South America. The world just got a whole lot smaller. In that context, the US is by far the most stable recipient for your investment, and its markets are also the driver for your current economic success.Deng Xiaoping, the former leader of China and the architect of China’s reforms that shifted the country to free-market capitalism, is famous for his quote that China should stick to its economic policies for one hundred years. China is thirty years in and has already taken enormously expensive steps (subsidizing exports by pegging to the US dollars for example) to ensure stability and continued growth. Reasons for this are also steeped in history, as we’ll in see future posts.
Sure, China is investing more in Europe, as the recent debt offerings from Spain and Portugal illustrate, but the broader context here is that a global economic downturn hurts China just as much or more than any other economy. Their domestic markets aren’t big enough or sophisticated enough to sop up the spare manufacturing capacity that would be created by a global downturn. China’s economic interests are driven by political and historical goals that go unseen by Western economic analysts.
The analogy to this situation is simple: as a construction company, you build a house, then rent it to a tenant who can also beat you up. You sell furnishings to him too. You’ve invested a lot in the home that you build, and all of a sudden, your tenant starts having trouble paying you back. Unfortunately, the house is so big and lavish that there’s nobody else who can afford it, or if they were to buy it, you’d have to sell at a steep or near-total loss. What do you do? You follow the wisdom that banks who own their own mortgages follow: you do what you can to work out a payment plan and look to keep the tenant in the house, while not humiliating him in the process. This way, both of you make it through hard times, and you can sell him a nicer house when he’s back on his feet in a few years and is looking to upgrade.
China is not about to jeopardize its future by focusing on short term issues and America needs to stop wringing its hands over non-issues. The problem isn’t China’s holdings (or any other foreign entity’s holdings) of our national debt, the problem is the national debt: it’s us. It feels a lot better to fear monger, but at the end of the day, we’re the problem.