China’s Role in U.S. Debt

America, by any measure, has a colossal National Debt. At an estimated $17.8trillion (103%[1] of the GDP output in 2014) many bondholders are likely to be wringing their hands in fear that a debt crisis may be looming. However, bondholders will not be the only ones concerned, especially when the debt is analysed. China owns $1.261 trillion[2] worth of US Government securities meaning it owns approximately 20% of the debt owed to all foreigners in total; with foreign holders of US treasuries at 45% this makes China an almighty fulcrum in a precarious situation.

Is this debt to China a problem? Why might China get rid of a considerable amount of USA debt? And what would happen if they did?

Firstly, with such a large portion of debt held by the Chinese it does leave the US to the whim of the Asian super power. If China were to choose to dispose of their US Government Securities then it is likely to raise interest rates as the U.S. tries to attract debtors to cover the colossal amount of money which would flow to China as it disposes of the debt. America would also struggle with China’s position as a powerful player in the world financial markets. With $3.2 trillion in foreign exchange reserves China has a large influence over the US economy and ‘markets react when China buys or sells US treasuries’[3]. By raising interest rates (a probable necessity) it would attract hot money flows into the USA as the US looks more attractive to investors. This would allow them to make up the difference from the hole left by a Chinese call for immediate payment. This increase in interest rates would affect the domestic US economy, including: the housing market and stock market whilst making the debt situation worse as the cost of servicing the debt rises. This is due to an increase in servicing the debt would increase the amount of money the USA pays to its creditors, thus worsening the effects of the outstanding debt without adding any more deficit spending. Unlike the problems with Greek debt the Federal Reserve is able to print as much money as needed to devalue its currency and thus lower the real value of debt owed. However, a rise in inflation against a GDP growth that is summed up by The Economist as “not wild”[4] would have detrimental effects upon the economy just as “wage growth is picking up”[5].

There is tension between the US and China over South China Sea as Barak Obama “calls on China to end ‘aggressive’ actions in South China Sea”[6] where China is trying to assert a claim of around 90% of the area including the Spratly Islands where there is an abundance of deep sea oil and natural gas reserves.  

The US has backed the Philippines with military support and so the Chinese government have claimed that America has ‘“double standards”, pointing out that other countries were involved in land reclamation in the past without eliciting such a fierce reaction from Washington.’[7] America’s involvement in the issue doesn’t hold America in a positive light in terms of a Chinese viewpoint and their actions are limited. Sanctions against China may provoke a response that includes the demanding of a debt repayment from the USA.

  More problems arise from how China and Russia don’t like how the US dollar is a massive reserve currency [8] whilst both are pushing to make their own mark on the reserve currency list. By the Yuan being a reserve currency it would “give countries more confidence to add the yuan to their currency reserves”[9] thus competing with the dollar supremacy.

Finally China has problems with poverty. At the end of 2013 82.49 million people lived below the IMF poverty line with China, with its own analysis, reporting it to be 122.38 million[10]. With China owed nearly $1.3 trillion dollars it may feel that it is responsible to alleviate a greater amount of people from poverty and thus exchange its dollars into yuan for domestic spending. But China’s target growth rate for 2015 falling to 7% would see the slowest expansion for the first time in more than two decades. China’s economy however, has been claimed to be trailing towards more domestically driven growth, instead of relying heavily on imports for growth. If Chinese investors decide that the future of the Chinese economy is in China then they might dispose of the US debt in order to raise investment. This would in turn push towards an economy which relies on the multiplier effect and the accelerator principle such like in many Western economies. Therefore Chinese creditors may demand payments for funds to boost a flagging economy to reboot the development of more infrastructure to support its export led growth. Perhaps most worryingly for the US is the nature of Government Securities. Securities are among the most liquid of the Chinese’s assets overseas and so if the need arose for more cash the US debt could be amongst the first to go.

Even if China doesn’t act on the debt, the USA’s American Dream won’t rub too smoothly with the idea of their freedom being impeded by a foreign country who doesn’t display the characteristics of being the best of allies. A survey by VOA News found that First, most Americans surveyed have unfavourable opinions of China as a whole, but do not view the country as a threat towards the United States at the present time. Second, most survey respondents expect China to pose an economic and military threat to the United States in the future, with more Americans worried about the perceived economic threat than the military one.[11]

So how likely is China to sell the Government Securities it holds in the US and other territories? The sheer scale of the amount of debt China owns means that, according to Ted Fisherman featured on ABC News, with an all-out debt repayment ‘the Chinese currency value is going to more than double’[12]. With this, Chinese exports- the forefront of their growth- would be destroyed as all Chinese exports become more expensive. The unemployment rate in China would spike as China no longer is having its goods or services demanded because of the new strength of the Yuan. Pessimistically, with events ‘heating up’ in the South China Sea, China in the future could maintain a steady employment rate in weapons manufacturing similar to WWII production. However, a war, even though with tensions high in the South China Sea is unlikely between USA and China with so much economically at stake.

The USA’s debt problem is the problem. China’s threat has manifested itself in being a rising super power causing unfavourable opinions from the USA. The power is still in the USA’s hands as long as bondholders have confidence in politicians to avoid the selling bonds and causing interest rates to rise. There is plausibility in the US never repaying their debts to China as stated by Matthew O’Brien in an Atlantic Article where he states “the government can just roll over its debts to perpetuity.”[13] However the amount of loans taken out by the US to fund its debt is spiralling out of control. Sods law predicts another economic crisis in the next 10 years[14] and America is soon going to be running out of people to borrow from. Ben Bernanke stated in 2010 “it is not clear when a country goes from treading in red ink to drowning in it”[15]. The debt must be stabilised to prevent a default and a global economic collapse, but with no room to cut spending or increase taxes the government is in a very difficult situation. Growth, and therefore better and more trade with China as a consequence, seems to many the only option. As seen in Europe austerity hasn’t yielded benefits and the only proven tactic is to, in the words of John Wheelen in Naked Economics, “increase the size of the pie” (GDP) so that debt takes up a smaller amount. Many think a house of cards has already been built, but China aren’t the ones shaking the table.

[1] Federal Reserve Bank of St. Louis, US, Office of Management and Budget, FRED, www.research.stlouisfed.org 2015

[2] www.moneymorning.com/2015/06/10/breaking-u-s-debt-to-china-will-destroy-the-u-s-dollar/, Money Morning Staff Reporters, (Accessed August 2015)

[3] John Olen, Economy in Crisis, 24/5/12, http://www.economyincrisis.org/content/what-if-china-dumps-our-debt (accessed August 2015)

[4]The Economist, 14/2/15,At Last, a proper recovery, www.economist.com/news/united-states/21643169-all-sorts-americans-are-feeling-more-prosperous-last-proper-recovery (Accessed August 2015)

[5] Ibid

[6] David Blair,The Telegraph, 1/6/15 www.telegraph.co.uk/news/worldnews/asia/china/11638044/US-surveillance-shows-china-positioning-weapons-on-contested-island.html (Accessed August 2015)

[7] Ibid

[8] Money Morning, www.moneymorning.com/2015/06/22the-real-reason-russia-and-china-are-dumping-u-s-debt/ (Accessed August 2015)

[9] The Economist, www.economist.com/blogs/feeexchange/2015/08/yuan-and-sdr (Accessed August 2015)

[10] The Economist, www.economist.com/blogs/freeexchange/2014/10/chinas-economy (Accessed August 2015)

[11] Michael Lipin, VOA News, 12/5/14, www.m.voanews.com/a1913088.html, (Accessed August 2015)

[12] ABC News, Ted Fisherman, What if China collected in U.S. debt? ,17/11/09, www.youtube.com/watch?v=T1dDIr0CbUo (Accessed August 2015)

[13] Matthew O’Brien, The Atlantic, 1/2/13, www.theatlantic.com/business/archive/2013/02/why-the-us-government-never-ever-has-to-pay-back-all-its-debt/272747/ (Accessed August 2015)

[14] Watch Out the world is not ready for the next recession, The Economist, Issue 13^th-19^th June, Page 13

[15]Josh Boak, The Fiscal Times, 7/4/13, www.thefiscaltimes.com/articles/2013/04/07/5-things-you-must-know-about-our-national-debt , (Accessed August 2015)