A common idea passed around is that China holds US debt and that if it decided to “demand payment” that the US would be crushed. Is this truth or myth?
I came across this comment on Diggnation. Would forumosa’s financial experts give me an answer?
That analysis is correct. Treasury instruments have a set time when they are paid off anyway, which is not in question.
Also, as a response to your friends who insist that China can destroy the U.S. by “demanding payment,” ask them to consider how exactly they would go about enforcing the demands.
[quote=“redandy”]That analysis is correct. Treasury instruments have a set time when they are paid off anyway, which is not in question.
Also, as a response to your friends who insist that China can destroy the U.S. by “demanding payment,” ask them to consider how exactly they would go about enforcing the demands.[/quote]
Well my best pals CCtang and AC Dropout, as I’m sure you’re well familiar with, say that all they’d need to do is demand payment, the US wouldn’t be able to pay up, and KAPOW! the United States is done for because the whole market will crash over a few billion dollars and so forth…
Why don’t you ask them? I’m not the expert here.
I’m really intrigued by this as every week or so I see someone posting somewhere about this that “THE US IS DOOMED BECAUSE WE OWE DEBT TO CHINA” and other stuff. There is even a few books about this. Most of the blame of course rests on the Clinton or Bush administration. If anything, I want to get to the bottom of this.
Get new friends that know something 
Well, economists are typically more troubled by trade deficits than they are about how much in Treasuries China owns. China’s interest is that their assets (U.S. treasury securities) maintain a high value, which will happen if the U.S. economy stays healthy. As for “demanding payment,” China couldn’t really enforce it without doing something that amounted to an act of war. So if they really believe China should start a war for the purposes of collecting on Treasuries, then by all means demand payment. Otherwise, China can either sell the securities, or get paid on schedule.
Some top economists say China’s demand for US Treasuries actually supports the US dollar, others say it will all end in tears for the dollar. One thing is for sure, that if the historical performance of Top Economists is anything to go by, they will both be wrong. An interesting conundrum which has been taxing the world’s greatest minds since Thursday last.
If China sold all its treasuries and raised short term rates high enough that it caused a crash in consumer demand in the US (relatively unlikely) - I wonder where they would sell the portion all of those widgets that they currently sell to the US? What then would happen once the capital account inflows slowed?
In other words, they can’t do that without shanking thier own economy.
On the other hand, if they feel that the US dollar is a poor investment, they can shift thier holding to the Euro over time, causing a weak USD. If the day came that people felt the Euro was a better ‘base’ trading currency because the USD is volatile or weak, and global market came to be denominated in Euros, not dollars, then the US would face the same FOREX risks when it came to the commodities markets that other countries do.
This is how it’s been explained to me at least…
The USA could pay China with weapons.
It would just save China all the trouble they are going to to build up a huge arsenal using USA funds.
Sort of cut the middle man out and get directly to the end result.
The PRC-USA money-go-round is the world’s first bonafide perpetual motion machine. Chinese producers keep lending and American consumers keep borrowing to buy the products that the Chinese make.
Schweet!
Next up. Grow your own money on your own money tree in your backyard. Seeds available here for $49.95 each. Money back guarantee. Restrictions apply.
[quote=“spook”]The PRC-USA money-go-round is the world’s first bonafide perpetual motion machine. Chinese producers keep lending and American consumers keep borrowing to buy the products that the Chinese make.
Schweet!
Next up. Grow your own money on your own money tree in your backyard. Seeds available here for $49.95 each. Money back guarantee. Restrictions apply.[/quote]
If you take it one step further - the Chinese are getting the funds to finance the US debt and invest in more production assets from the overseas trade and investment.
It’s all fun and games until productivity and wealth creation slows in the US so that the US can no longer afford to borrow.
[quote=“Elegua”]On the other hand, if they feel that the US dollar is a poor investment, they can shift thier holding to the Euro over time, causing a weak USD. If the day came that people felt the Euro was a better ‘base’ trading currency because the USD is volatile or weak, and global market came to be denominated in Euros, not dollars, then the US would face the same FOREX risks when it came to the commodities markets that other countries do.
This is how it’s been explained to me at least…[/quote]
This is already beginning to start, a move has already begun to have oil priced in Euro’s, whether it succeeds or not is a different issue.
[quote=“Elegua”][quote=“spook”]The PRC-USA money-go-round is the world’s first bonafide perpetual motion machine. Chinese producers keep lending and American consumers keep borrowing to buy the products that the Chinese make.
Schweet!
Next up. Grow your own money on your own money tree in your backyard. Seeds available here for $49.95 each. Money back guarantee. Restrictions apply.[/quote]
If you take it one step further - the Chinese are getting the funds to finance the US debt and invest in more production assets from the overseas trade and investment.
It’s all fun and games until productivity and wealth creation slows in the US so that the US can no longer afford to borrow.[/quote]
Don’t be so negative. When the Chinese get so rich they buy up McDonald’s and Wal-Mart with their spare change they’re still going to need plenty of hamburger technicians and hospitality specialists. The less-skilled jobs at the McWal-Marts of the future though shouldn’t be counted on as they’ll probably be reserved by law for underprivileged guest workers from Mexico once immigration reform laws have been “fine-tuned.”
I’m not being negative. I actually have confidence in the US’s ability to keep generating productivity gains.
This system works to a certain degree since massive amounts of wealth have been created in the developing world while the developed economies have continued to grow. It’s not like the money is just draining out of the developed economies.
Yes, hamburger flippers and line workers are going to have trouble - just as they always have.
One of the questions that has to be answered here though is “Would the CCP sacrifice China’s economy for political expediency?”
Could it, even? What has changed since the days the answer to that question was an unequivocal “yes”, and when did the change take place? There are people out there putting lots of money into China who believe the CCP does not control the Chinese economy and some who even believe the CCP’s political and administrative control over China is crumbling. But is it? If the political questions can be answered the economic ones will answer themselves. And the big political question is “Has the CCP given up political control of China such that the current economic trends are irreversable without destroying the CCP?”
In the past any conflict between economics and CCP control of China has always been resolved in favour of the latter. If this intention to retain political control has changed, then we have crossed a huge watershed in China’s history and I want to see more evidence.
The original claim about the implications of holding US debt is partly right, and partly wrong. Some others have already discussed why.
Yes, of course US debt is structured as a contract with a specific coupon rate and repayment schedules. No holder of this category of debt can “redeem” this debt ahead of the contractually listed maturity date. Beijing can not call up Washington DC tomorrow and request a billion dollar wire transfer in the morning. This is typical of debt securities, whether corporate or sovereign.
But what the original author didn’t understand, and what ShrimpCracker apparently didn’t learn at the Learning Annex, is that:
- a significant percentage of this debt is in the form of short-term treasury bills (ranging in maturity from a few days to 6 months),
- and even longer-term notes (2, 3, 5, 10 year maturities) are constantly maturing.
The US doesn’t really “pay off” bonds when they mature; it’s not like there’s a large floating piggy bank somewhere where trillions in dollars are lying around. The US treasury essentially issue new debt every month and use those earnings to pay off the debt maturing that same month… + whatever new debt has been accumulated.
And so, the US treasury holds auctions for billions of dollars in US debt every month, because billions in existing US debt is maturing every month. China’s ability to influence US lending comes in this context. It doesn’t have to demand “repayment”; it can just choose to not roll over its maturing debt into new notes. It can just choose to keep the US dollars that it is paid by the US treasury, and trade it for some other asset, or just bury it in a big hole.
Someone else would have to lend money to the US federal government to pay off this maturing debt. There’s not much doubt this debt would be purchased by someone, but if China chose to leave the market, then just as econ 101 suggests when supply/demand changes… the prices investors would pay for US debt would fall, perhaps very dramatically. The result would be far, far higher short-term interest rates + higher cost of borrowing, and the crippling consequences that would represent to the United States economy. (Imagine short-term interests rates surging to 15%+ within the course of a few months.)
And as someone else mentioned, Beijing could always sell debt before maturation too. It’d all come back to impacting the US treasury in the same direct way: reduced interest in its next issue of debt.
Would this be mutual economic self-destruction? Quite possibly. I’m not good at predicting the results of games of “chicken”, but it’s safe to say there would be a lot of pain on both sides of the Pacific Ocean.
[quote=“hexuan”]
In the past any conflict between economics and CCP control of China has always been resolved in favour of the latter. If this intention to retain political control has changed, then we have crossed a huge watershed in China’s history and I want to see more evidence.[/quote]I don’t think that watershed moment has been passed.
A very healthy percentage of the Chinese economy is still controlled by state-owned enterprises. These state-owned enterprises have senior management directly appointed by the PRC central government. Beijing still has significant control over the major pillars of the Chinese economy. Not to mention that the Beijing central government maintains full ownership over all land.
I do think this is gradually changing with the participation of foreign enterprise + private capital, but still far from a major “watershed” moment.
I think in terms of economies it goes like this. PRC can no more demand advance pre-payment from the USA over its bonds without leveraging military might, than the USA can demand PRC to free-float the Yuan on the USA timetable without flexing some military muscle.
I believe Elegua is on the right track on what influence PRC has over USA economy by just dumping their USA bonds on the open market.
Now if Japan and PRC decided it was in their best interest to unload USA bonds at the same time, that would be an interesting situation to comtemplate. What type of economic alliance could the PRC and Japan form to engage in hostile economic warefare with the USA.
[quote=“ac_dropout”]I think in terms of economies it goes like this. PRC can no more demand advance pre-payment from the USA over its bonds without leveraging military might, than the USA can demand PRC to free-float the Yuan on the USA timetable without flexing some military muscle.
I believe Elegua is on the right track on what influence PRC has over USA economy by just dumping their USA bonds on the open market.
Now if Japan and PRC decided it was in their best interest to unload USA bonds at the same time, that would be an interesting situation to comtemplate. What type of economic alliance could the PRC and Japan form to engage in hostile economic warefare with the USA.[/quote]
But unfortunately with your merchantilist views of economics you only have half the picture - you still don’t understand that they would be cutting thier own throats economically since they depend just as heavily on the current account flows. Were those to stop, all hell would break loose.
Having a pegged currency doesn’t really create an economic advantage - that is just political BS. What is does do is shield a partially liberalized economy with a very poorly regulated and weak financial sector. At some point in time, this will have to be dealt with. Hoping that the economy will grow enough to create a soft landing is likley wishful thinking.
Exactly. A pegged currency is as much a disadvantage as an advantage. Lost in all this talk about the pegged yuan in the year 2006… is the pegged yuan in the year 1997. In the midst of the Asian economic crisis, as the value of other local Asian currencies plummetted, Beijing made the policy decision of holding firm to its currency valuation. This implied, on the short term, a greater pain for the Chinese economy since it instantly made Chinese exports far more expensive than those coming out of southeast Asia.
The decision was made because it would imply greater stability for all businesses doing business in/with China. It stopped a vicious cycle of growing depreciation, and helped southeast Asian currencies get back on their feet.
As far as the implications of dumping US bonds… I’d equate this to driving very fast on a slick highway. If it was a truly hostile “dumping” which destroyed the US consumer over night, it would obviously be close to economic suicide for China. It’d be like slamming on the brakes and giving a hard turn on the wheel simultaneously. I wouldn’t expect that course of action unless war was already upon us. The goal for China must be to develop its own domestic economy, and wean itself of the bloated teat of American consumers.
It’s like a small town lender with only one customer, a high-income but increasingly debt-ridden big spender who’s frittering away all his income on his gun-collecting hobby and shopaholic wife.
The few other people in the small town with the big spender’s wealth don’t have his addictive need for borrowing and are looking on aghast at what they suspect may be a fiscal dance of death.
The lender sees a train wreck down the road because its big-spending customer seems to be losing his focus on his income-producing work because of his obsession with his gun hobby and profligate wife and so may one day find himself “out of a job” and “unable to pay.”
“Not a problem,” say some local pundits. “It’s not a good situation but they’re both locked into it so it will probably never explode and hurt the rest of us.”
Others though aren’t so sure since those words have an ominous historical ring to them, harkening back to other such ill-fated fulminations of overoptimism as “Even God Himself couldn’t sink this ship.”
Who really knows where this fiscal alchemy – this fiscal madness – will end up?