The United States owes over $1 trillion in debt to China. This massive debt is the result of a trade imbalance between the two countries over decades. The US imports far more goods from China than it exports to China, creating a trade deficit. To fund this deficit, the US government sells Treasury securities to China, which China buys using its large foreign currency reserves. This influx of money from China has allowed the US government to fund its budget deficits and consumer spending. However, it has also made the US reliant on China as a lender.
What is the history of China lending money to the US?
China first started buying significant amounts of US Treasury securities in the early 2000s. In 2000, China held $60 billion in US debt. By 2010, this had increased to over $1.1 trillion. There were several factors driving this rapid increase:
– China’s entry into the World Trade Organization in 2001 gave its exports even greater access to the US market. Chinese exports to the US soared.
– China actively intervened in currency markets to keep the value of its currency, the yuan, lower compared to the US dollar. This made Chinese goods very cheap for US consumers, further widening the trade deficit.
– China was undergoing rapid economic growth, generating large trade surpluses. The Chinese government invested these surpluses into US Treasuries to fund the deficits.
– US spending was increasing in the 2000s due to tax cuts, wars, and expanding entitlements. This drove up budget deficits, increasing the government’s need to borrow.
By the late 2000s, China had become the largest foreign holder of US debt. The US reliance on China to fund its twin budget and trade deficits had become a potential vulnerability.
How much US debt does China currently own?
As of October 2022, China held $980 billion in US Treasury securities. This makes China the second largest foreign holder of US debt after Japan ($1.3 trillion). Overall, China owns about 4% of the $23 trillion in publicly-held US debt.
While China was the biggest foreign owner of US debt for many years, its holdings have declined since peaking at nearly $1.3 trillion in 2013. Japan surpassed China as the top holder in 2017.
China’s reduction in Treasury purchases reflect its broader move to diversify away from dollar-denominated assets as its foreign exchange reserves have stabilized. However, China remains a major buyer of US debt given the depth and liquidity of the US Treasury market.
Breakdown of Major Foreign Holders of US Debt (Oct 2022)
| Country | Holdings in Billions |
|---|---|
| Japan | $1,306 |
| China (Mainland) | $980 |
| United Kingdom | $499 |
| Luxembourg | $286 |
| Ireland | $287 |
| Brazil | $255 |
| Switzerland | $233 |
| Cayman Islands | $227 |
| Hong Kong | $215 |
| Taiwan | $205 |
Why does China buy so much US debt?
China accumulates large quantities of US debt for a few key reasons:
– To manage exchange rates – China buys Treasuries to manage the value of its currency against the dollar and keep exports competitive. Buying Treasuries prevents the yuan from appreciating.
– High returns – US Treasuries are seen as a safe investment with relatively good yields. China uses its dollar trade surplus to earn interest.
– Dollar dominance – Owning US debt gives China access to the global reserve currency to conduct international trade and finance.
– Fund deficits – As China runs sustained trade surpluses against the US, it uses the surplus dollars to fund the deficits by buying US debt.
– Limited alternatives – There are few assets that offer the scale and liquidity of the US Treasury market, making it appealing despite low yields.
What are the risks of China owning so much US debt?
While China’s large holdings of US debt highlight its economic interdependence with the US, this lending relationship does create some risks, including:
– Leverage over the US – In theory, China could threaten to sell off its Treasury holdings to deter US policies it opposes, triggering higher interest rates in the US. However, most experts agree China would not pursue this nuclear option as it would also inflict major harm on China’s own economy.
– Pressure on US interest rates – If China were to reduce its buying of Treasuries substantially, it could potentially nudge US interest rates higher, raising the government’s borrowing costs. However, global demand for US debt remains robust.
– Less seigniorage for the US – Seigniorage refers to the profits a country earns by issuing currency that other countries demand. The US benefits less from seigniorage with China holding dollars rather than buying US goods.
– Risk of sudden sales – China could decide to rebalance its foreign exchange holdings quickly for economic reasons, which could disrupt the US if a rapid sell-off of Treasuries ensues. However, any changes are likely to be gradual.
– Strengthens China geopolitically – China’s dollar holdings symbolize its economic leverage over the US and ability to influence US economic conditions if deployed aggressively. This has implications for the US-China strategic rivalry.
How dependent is the US government on China buying its debt?
The US relies heavily on foreign investors, including China, to finance its budget deficits. Foreigners own about 30% of the US national debt. However, the US is not wholly dependent on China alone to fund its deficits due to strong global demand for US debt:
– Treasuries are seen as safe assets, creating natural demand from global investors looking for stability, liquidity, and positive yields. This insulates the US from over-reliance on any single buyer.
– Japan, UK, Ireland, Brazil and others also buy large sums of Treasuries, providing funding alternatives to China. The diversity of foreign holders reduces risk.
– The Federal Reserve owns 20% of US debt and can buy more to offset any fall in foreign demand via quantitative easing programs. This monetary policy leverage provides room for the Fed to act if China were to sell.
– US debt is considered the premier global reserve currency. This gives the US exclusive power to issue debt in its own currency that the world uses, providing inherent demand for Treasuries.
– Private domestic US investors, banks and institutions hold half of the US debt, limiting reliance on foreign creditors overall.
– If needed, the US government could pursue financial repression tactics such as compelling domestic banks to buy Treasuries by regulation.
Could China’s debt holdings give it leverage over US policies?
In theory, China could threaten to sell off Treasuries in an attempt to deter US policies it opposes, like arms sales to Taiwan. However, most experts agree this is an empty threat:
– Weaponizing Treasuries would inflict severe self-harm on China’s economy by driving up US interest rates and strengthening the yuan against the dollar, crushing Chinese exports. This scorched earth approach would risk Chinese leaders’ legitimacy.
– Sudden selling of Treasuries would destroy China’s wealth stored in dollar assets, contradicting prudent economic stewardship. China still relies heavily on a stable US Treasury market.
– Threats to unload Treasuries would be highly destabilizing to the global financial system and could drive investors away from US debt, which is not in Beijing’s interest.
– There are no viable alternative assets for China to divert its $1 trillion in reserves into that offer equal security and liquidity.
– Pressure could drive the US toward economic nationalism against China. Any perceived blackmail by Beijing could provoke a backlash.
– Such a confrontational move would damage relations between major trade partners, going against China’s stated multilateralism principles.
Conclusion
China owns nearly $1 trillion in US debt, making it the second largest foreign holder after Japan. This reflects a decades-long trend of China accumulating Treasuries to manage its own currency, earn interest income, and fund the US trade deficit. While this lending relationship has sparked concerns about leverage, most experts agree China would not aggressively wield Treasuries as a weapon due to the self-harm it would inflict. Demand for safe US assets remains spread across diverse buyers, limiting the risks of over-reliance on China. Despite tensions, the economic costs of China suddenly dumping Treasuries likely outweigh any gains.
