The Truth About Our Debt to China

Conventional wisdom in politics is often wrong, especially when it comes to policy.

Conventional wisdom says that the national debt is a huge short-term problem for the American economy.  In reality, debt is a long-term problem; eventually, it could lead to higher interest rates and even hyper-inflation, but right now inflation and interest rates are both pretty low by historical standards.

Conventional wisdom says that Mutually Assured Destruction (MAD) kept us safe through the Cold War.  In fact, MAD makes very little sense; after all, it required that the USSR believe that the USA is so vengefully sadistic that we would respond to any nuclear attack by annihilating every Soviet city (and vice versa).  Think of it this way; if your neighbor raped and murdered your wife, is raping and murdering every single member of his family the rational response?  That is the “logic” of MAD.

And conventional wisdom says that it is a strategic problem for us to have “borrowed money from China.”

You heard it again in last night’s debate.  To quote Governor Romney: “Well, first of all, I will eliminate all programs by this test, if they don’t pass it: Is the program so critical it’s worth borrowing money from China to pay for it?”  Well, let’s dig in to what it means to have “borrowed money from China.”  

First of all, the United States government’s debt bears almost no resemblance to the debt that an average person accrues.  Say that you want to borrow money from a bank.  You go to the bank of your choice, fill out a loan application, and the bank decides whether to lend you money and on what terms.

The United States government does no such thing.  If the United States government does not have the cash on hand to pay a particular bill, it issues a bond.  Essentially, it offers investors the opportunity to invest in the future of the United States government, at a certain interest rate (where the interest rate varies depending on the exact nature of the bond).  Once those bonds are issued, they are bought and sold all over the world.  Why?  Because the United States government is the safest investment on the planet.  Let me repeat that, for emphasis: the United States government is the safest investment on the planet.  That makes them very popular with investors.  Because they are so popular, the United States government doesn’t need to offer high interest rates in order to sell it’s bonds; in fact, US bonds have really, really bad interest rates.  And yet people still buy them.  Why?  Because (and everybody say this together now) the United States government is the safest investment on the planet.

So where does China fit into all of this?  The Chinese government has a lot of cash sitting around.  Essentially, China’s economy has been doing very well and they don’t exactly break the bank spending on their own people.  And China needs a safe place to park all of that money.  So what has China bought?  United States treasury bonds, AKA American debt.

So have we gone hat-in-hand to China asking for loans?  Nope; China has bought American treasury bills on the open market, just like everyone else.  Could China call in that debt, like a bank calling in a defaulted loan?  Nope; US treasury bonds are simply a promise to pay the bearer a certain amount of money over a certain period of time, and they can’t be changed by the bearer.  Could China sell of all of their debt at once and send the international price of American bonds plummeting (thereby spiking interest rates and hitting the American economy)?  Yes, they could.  And in the process, China would lose a ton of money on those bonds (because they would kill the value of their own accrued asset), they would damage the economy of the largest consumer of their goods (which would hurt their own economy), and there are still plenty of other buyers out there for American bonds in the long-run, so it wouldn’t have much long-term impact.

Really, this bit of conventional wisdom is just playing on American fears.  Fears that America is no longer the dominant nation in the world.  Fears that our debt has grown too large and too unwieldy.  Fears that China is threatening American hegemony and interests around the world.  And all combined with a basic misunderstanding of American debt, because people want to apply the lessons they have learned about their own personal debt to the debt of the American government–which are actually vastly different things.