Monday, March 15, 2010

China And American Debt

Alan recently mentioned his deep concerns about Chinese purchases of Treasuries.

Here's Paul Krugman today:
What you have to ask is, What would happen if China tried to sell a large share of its U.S. assets? Would interest rates soar? Short-term U.S. interest rates wouldn’t change: they’re being kept near zero by the Fed, which won’t raise rates until the unemployment rate comes down. Long-term rates might rise slightly, but they’re mainly determined by market expectations of future short-term rates. Also, the Fed could offset any interest-rate impact of a Chinese pullback by expanding its own purchases of long-term bonds.

It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies, such as the euro. But that would be a good thing for the United States, since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.

So we have no reason to fear China.

I think Krugman is a bit too nonchalant about the medium- to long-term impact of this shift, but it does disprove the idea that Chinese owning our debt is some sort of catastrophe.

Actually, I understand why people think this way. Individuals often hate debt and debt payments. But sovereign debt isn't quite the same. For starters, sovereign debt is sovereign and a country can ultimately and legally tell their creditors to shove it. Moreover, countries have additional tools available to them. Krugman makes mention of one of them above, which is to say, simply, that if the Chinese stop buying our debt, then the government, through the Fed, can simply print new money to finance the debt. Long-term it will spur inflation, but it can work over the short run.


Alan Howe said...

We cannot blithely tell our creditors to "shove it."

We would have to expect a complete absence of countries and banks willing to loan to us. That would compel us to balance our budget through cuts and tax increases. The antagonism we created will require a strong defense to ward off attempts by creditors to "repossess" territories under our control. Oil-producers who also hold our debt may charge us extra to recoup their losses. A likely reduction in investment in infrastructure and education (see Virginia's new budget) to support adequate defense spending in the newly more dangerous world, would undermine our position and perhaps lead to long-term degradation of our power and influence.

Debt has us over a barrel. Creditors will protect themselves from severe harm long before we have them over a barrel. We are not so loved in this world that nations like China will come to our rescue.

FLG said...

First, I'm not saying that we could blithely do it. However, a country can, in point of fact and due to its sovereignty, default on debt in a way that individuals and corporations cannot. Yes, there would be ramifications, as you explain, and I'm not in favor of it. But governments do, again in point of fact, have that open to them in a way individuals do not.

Second, you are extrapolating what happens with individuals to countries. Listen, I've been reading up, at length, on the nexus between finance and power, and while it's not ideal to be in debt, it's not the end of the world that you make it. China doesn't "have us over a barrel."

Seriously, I know you have a personal aversion to debt, but it's coloring your analysis in a way that's exaggerating the problem. No, being in debt to China is not preferable to not being in debt to China, just as not being in debt is preferable to being in debt. But it's certainly not the end of the world.

Now, I definitely would like our government to get its long-term financial house in order, but I'm not terribly concerned about who holds the debt.

Anonymous said...

If I were Alan, I'd cite Mississippi's repudiation of its foreign debt, subsequently enshrined in the state constitution, as a direct cause of the state's long, sorry occupancy of the bottom of nearly every barrel there is.

But I'm not, so I won't.

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