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Fear the Dragon?
The casual joke turns on China knocking on our door in the middle of the night on a repo call. Like a lot of jokes it’s a way of laughing off a genuine fear – that they US is slowly being owned by a nation that isn’t exactly friendly and we have no reason to trust. Paranoia sometimes sets in when people wonder why China would loan us all this money in the first place – has this been a plot all along?
A hard look at the Chinese Dragon shows that not only is there little to fear from them, they have far more reason to be afraid of us. And they’re pretty open about it, too.
China’s interest in the US is not what they sell us. The total value of the goods and services in the US that are made in China is 2.7% of our economy, or a bit over 5% of their economy. They would certainly miss the income if we crashed, but since China has been growing at over 9% a year for a long time they’d make it up quickly.
What has driven their appetite for US Treasury Bills is instead their entire strategy for growth, which is to export like crazy. About 30% of the Chinese economy, or $1.8T in 2010, is exported – quite a bit higher than the worldwide average of 21%. In order to do this they keep reserves in US Dollars because that is the global currency. Around the world, everything is priced in US Dollars, and everyone trading has to keep reserves of US Dollars. When possible, nations prefer T-Bills over Dollars – they are same thing, except T-Bills pay interest.
The exact figure of Chinese exports is important compared to the value of T-Bills that they hold. As of June it stood under $1.2T, or about 10% of all our debt. More to the point, it’s running about 6-8 months of total Chinese trade. Global appetite for our debt is always similar, which is to say that our debt of $14T has to be compared with global trade figures of about $16T total. If anything, China is running pretty lean.
Our ability to finance 30 years of nearly constant deficits has everything to do with the increase in global trade rather than our own economy. As long as trade increased, the global hunger for T-Bills increased right along with it. What has happened recently is that we got ahead of that curve during the 2008 slowdown and sent out more paper than we ever have before. As long as worldwide investors see this as a risk-free investment they can absorb it – but there are limits. That’s the bind we are in.
Meanwhile, China knows that they cannot keep up their growth forever. An export based strategy is the flipside of a borrowing base strategy, which is to say that China and the US have grown to be dependant on each other in ways that neither is comfortable with. The problem for China is that insanely high growth has to be met with infrastructure improvements, which is to say investment in their own nation. But exports require an investment in the US because the Dollar is the reserve currency around the world. That’s the balance they’ve had to strike to move up as rapidly as they have, and it’s precarious. It can’t hold forever.
That’s why China is pretty vocal about US borrowing – and has called for international supervision of the US Dollar. It’s not just that they are the largest holder of our debt. China is counting on a worldwide system, based on US Dollars and a careful balance, to lift them rapidly.
So what do we have to fear from the Chinese holding our debt? A lot less than they have to fear from us. There is no Chinese Dragon plotting to loan us into slavery or any other complicated scheme. Instead, we have a nation playing by the rules but pushing things as hard and fast as they possibly can in order to rapidly assume their place among developed nations.
What we do have to fear is a push to remove the US Dollar as the reserve currency, making all those T-Bills far less valuable. That can come from other nations as growth continues throughout the developing world despite the Depression in the developed world. We can reasonably expect there will be a push from developing nations once their economies are half of the world’s GDP. And yes, we can expect China to lead the push to either ditch or seriously reform the US Dollar Standard. That’s when it all gets very interesting.
This piece contains a large number of external links with some very interesting observations, data, and commentary. There are also several past Barataria essays linked. If you wish to know more about the topics please follow the links. Thank you!