The U.S. federal government runs a gigantic budget deficit, which will hurt the economy for the next decade. China buys some of the bonds sold in order to raise the money to finance that deficit. The PRC has about $800 billion in official holdings of Treasuries, plus perhaps that much in other types of holdings.
The conventional wisdom is that the U.S. needs PRC financing to continue our wild spending. The conventional wisdom seems to be wrong. Partly because of the damaging jump in the size of the deficit, Chinese bond purchases are now unimportant both in terms of size and, crucially, in terms of impact.
Official Chinese purchases of US Treasury bonds are on pace to fall below $100 billion for 2009, while the federal government deficit soars to $1.4 trillion. When the PRC stopped financing our deficit, it was supposed to send commercial interest rates flying, making mortgages and other borrowing much more expensive and severely crimping our economy.
Yet U.S. commercial interest rates were lower at the end of 2009, with Chinese financing dwindling toward nothing, than at the end of 2008, when official Chinese purchases were equivalent to nearly half the federal deficit. (1) Chinese bond purchases no longer seem to matter, if they ever did.
To add to that, when Chinese bond purchases were large, it was because Beijing had no choice. The PRC can take in a great deal of money from the world, through its trade surplus and other activities. But because of the same rules that keep the Chinese currency undervalued, Beijing cannot spend foreign currency at home. Most foreign money disbursed in China by law ends up right back with the central government. (2)
That can leave the PRC sitting on a huge pile of dollars and the U.S. economy as the only place big and solid enough to absorb it back. China has not been lending, they’ve been investing, the only way they can.
Finally, the bulk of China’s pile of foreign money can be traced back to the Sino-American trade gap. On exactly the same lines, the PRC ties its currency to the dollar. Linking themselves closely to the American economy that way is also the best choice they have. In contrast, any American financial dependence on China has almost vanished.
The misconception that China is America’s banker should vanish as well.
Derek Scissors, Ph.D., is Research Fellow in Asia Economic Policy in the Asian Studies Center at The Heritage Foundation.