Think about this for a moment. How can China lend dollars to the US government when the US is the sole and unconstrained issuer of US Dollars? How can China even have Dollars unless we first gave them to China? Clearly, something else is going on.
There's a lot of fear mongering over our national "debt" to China since the word "Trillion" is such a big number. The doomsayers like to tell us that when China stops buying our debt, we will have no one else left to buy it and our interest rates will rise rapidly like they did with Greece leading to a collapse of the US Dollar and hyperinflation... or at least something bad will happen.
Happily, these people have no clue about how sovereign currencies actually work and what happens when two countries do business together!
Remember that, unlike Greece that gave up their currency, the US is a currency-issuer. Since we have a Central Bank that can choose to buy bonds any time it wants to meet its target interest rate, no bond market has any power over the US to force high interest rates or cause a default on the "debt".
Some of you may recall that there was a similar hysteria over Japan in the '80s? Naturally, they were a big trading partner at the time. No one seems to mind that anymore but the same dynamic was at play and much of the same fears arose.
So what exactly is China's US dollar debt all about? Niall Ferguson calls it Chimerica - it is the result of a mutually beneficial and symbiotic trade relationship. Here's how it works:
- China (and other countries) want to sell a lot of products to the USA; more than they want to buy.
- In the US consumers and businesses want to buy a lot of products from abroad at low prices.
- So the US receives real goods; China receives US dollars.
- Note that in real terms, the US is gaining since we get more real things than we can make in our own country.
- China is working hard for low wages to make stuff for us and all they get are credits to a bank account.
- The Chinese companies that sell these products need to buy supplies and pay wages in Renminbi so they exchange the US Dollars they receive at their central bank for their local currency.
- The Chinese central bank now accumulates these excess reserves of US Dollars in the form of an account at the US Federal Reserve Bank (all nations and international banks that deal in dollars have accounts there). They now have a choice:
- Hold onto reserves of US Dollars that pay no interest.
- Buy a Treasury Bond that earns interest.
- Of course they choose to buy bonds to earn interest.
- What just happened? China now owns some of our "debt" but it's simply an accumulation of US Dollars that result from our large trade volume. We also hold the "debt" of countries that we run negative trade balances with. We just happen to have a very large one with China right now. In another ten years it may be another country.
You might ask what happens if China suddenly wants to sell its bonds. Well, if they sell, they have to find someone to offer them another currency they prefer (let's say Canadian Dollars), in which case the Canadian Central Bank now has US Dollars and will still prefer to convert them to bonds and earn interest. And even if they didn't, the Fed can always buy and sell bonds to keep the interest rate where it desires. In fact, sovereign currency-issuing nations don't even need to sell bonds (we'll get to the misplaced fear of inflation in a later post).
Interest payments are made simply by the Fed crediting their account with new money (no tax increases are needed to "pay for" interest, no matter how large it gets).
So there's no reason to fear the debt with China or, for that matter, any other nation or financial institution. Sovereign nations can't be threatened by bond vigilantes - that's a leftover from our gold standard, fixed exchange rate days.
We simply are not reliant on China to give our government US Dollars to spend! And we never will be! Warren Mosler (see below) describes the situation this way: we give China (and other savers of US Dollars) the ability to take their money that is held in a checking account at the Fed and giving them a term savings account instead (like a CD). That's really all a Treasury bond is - a short term interest-earning account at the Central Bank.
Describing it as a "debt" to China is very misleading. Whenever China wants to be "paid back", the Fed simply converts their holdings back to reserves (moves money from the savings account to the checking account). The debt could be paid off tomorrow, and again, no tax increases would be needed! But of course China will simply seek to buy bonds again so they earn interest!
We desperately need a new dialog about our economy - one that is based on a proper understanding of the role government money plays in balancing the private sector and foreign trade.
Join the discussion; educate your friends and members of congress!
