Why Does China Buy U.S. Debt?

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As the market economy and worldwide influence of China grows, so too does the nation's significance to the U.S. economy. China's manufacturing industry is highly productive, exporting goods to many Western markets, including the U.S. But the U.S. reliance on China is actually twofold; not only are we one of the biggest consumers of Chinese goods, but China is also one of our biggest creditors.

History

  • According to publications such as "The Financial Times" and "The Economist," China has always been one of the largest economies in the world. The People's Republic of China (PRC, or Mainland China) is the third-largest economy in the world, behind Japan and the U.S., as of 2008. Much of China's economic might lies within its industrial and manufacturing sectors, which account for nearly half of the nation's gross domestic product (GDP). China's factories are advantageous to U.S. businesses because they provide far cheaper labor than for goods that are manufactured domestically. As such, many distributors in the U.S. buy Chinese-manufactured goods or Chinese-brand goods.

Identification

  • Public debt is incurred in the U.S. when individuals buy government bonds. A government bond is essentially a loan to the U.S. government. These are advantageous to the bond holder because the value increases according to interest rates, resulting in a profit when the bonds are redeemed. Meanwhile, the government has increased spending power (i.e., leverage). For the most part, the U.S. debt is owed to its own citizens. However, as U.S. expenses grow, the government increasingly turns to other nations to raise capital. This results in external debt.

Function

  • In the case of China, one of the greatest contributors to the U.S. indebtedness to China is the fact that the U.S. purchases far more goods from China than China purchases from the U.S. Demand in the U.S. for Chinese goods outweighs demand for U.S. goods in China by nearly 500 percent, according to the "Washington Post." With fewer goods to return in kind and a falling dollar, the U.S. has, in essence, been buying Chinese goods on credit. Also contributing to the amount of U.S. debt that China holds is the amount of money that the U.S. borrows from China to raise capital for other government spending.
    Historically, buying U.S. government bonds has been a safe investment, since the risks of the U.S. defaulting on the loan have been very low, while the chances of the dollar increasing in value have been high. As the U.S. hits rough patches in its economy--such as the subprime mortgage crisis--and needs to raise money in an attempt to steady the turbulent market (the massive bailout of investment banks and financial services companies, for example), it can turn to other nations for extra spending power. This stimulates the consumer economy, because loans and mortgages underwritten by foreign investors result in lower interest rates and more flexible credit terms.

Significance

  • According to the "Washington Post," China became the largest foreign creditor to the U.S. in November 2008. Because of this, China has great influence over the American economy. Should China choose to stop buying U.S. debt, it would cease one of the largest in-flows of capital into the country, making it harder for businesses to obtain loans and raising interest rates and commodity prices for consumers. If China were to begin selling U.S. debt--essentially cashing in its government bonds--it would actually remove money from the U.S. economy, creating an even more dire situation.
    Another issue is the disparity between the currencies. In the global economy, the dollar has much more buying power than the yuan (China's denomination). This makes U.S. goods more expensive to export to foreign nations than Chinese goods. As such, China's prices for manufactured goods are far more competitive than those of the U.S.

Considerations

  • The U.S. has a somewhat checkered history with China. The U.S. was at odds with China during its communist rule. This tension nearly culminated in all-out war during the Clinton administration, when the U.S. vowed to defend democratic Taiwan. Relations between the U.S. and China have since cooled, fostering in a new era of economic alliance. Now, although our economy and our lifestyle greatly benefits from the cheap labor in China, the human rights policies and environmental issues clash with the U.S. standards. The government in China is somewhat of an anomaly; although China has a market economy, freely trading with foreign nations such as the U.S., there are many restrictions on free speech, immigration, religion and freedom of assembly.
    The danger in the U.S. coming into a dispute with China is the massive financial clout China has over the states. As a source of much of the spending power of the U.S. government, as well as affordable goods for consumers, the severing or exploitation of these economic ties could wreak havoc on the U.S. economy--freezing credit, removing capital from the system, sending prices skyrocketing, bankrupting businesses and eliminating jobs--essentially causing the U.S. to fall into a depression. Because of this, dealings with China are more delicate and critical than ever.

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