Bonds Between China and the USA

Recently I heard someone on radio say that the Chinese are financing America’s debt and that we were in trouble if they suddenly quit doing it. The idea was that a parent was going to “cut us off” without a cent. But the Chinese are not doing us a favor as a fond parent might. They are making an investment in the most business-like sense. It pays for them to invest in America’s bonds.

When a person says China is financing our debt, he is really saying that the Chinese bought a great deal of the bonds issued by the American government. The Chinese made an investment. If they “suddenly quit” financing our debt, how will they do it? One of two ways, maybe a bit of both. 1), China will sell some existing bonds, and 2), China will hold other bonds to maturity but will not buy more when those bonds mature.

In the first case, the Chinese will sell their bonds to someone else, just as they would any other investment. They are unwilling to take a loss--they made the investment in America for safety and a likely return on their investment. If they dump a lot of bonds at once they face a drop in the price of those bonds. Also, when they sell their bonds they will have to invest in some other government’s bonds. Lots luck to them.

America, with all its Chinese-owned bonds suddenly dumped on the market, will see lower priced bonds which means a higher interest rate in the future. However, there will be little immediate impact. Someone will buy the bonds and America will not be involved in the transaction.

In the second case (when China suddenly stops financing America’s debt) as Chinese-owned bonds mature China will buy no more of them. It will invest somewhere else. Again, lots of luck. China will buy another nation’s bonds, out-bidding someone else and that other person or nation will buy America’s bonds.

In order to sell a new issue of bonds, America may have to raise interest rates. In the today’s world, which seems to be awash in capital, the rise in interest rates will not be pleasant but will not be overwhelmingly large, either.

So do economists quake at the thought of China suddenly refusing to “finance America’s debt”? None that I know of, for the reasons given. And, if they are old enough they recall a time twenty years ago when people were afraid that Japan would suddenly refuse to finance America’s debt. Today’s pronouncement about our debt has a familiar sound and when decoded, it means “go back to school and take an economics class.”

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