Why does China hold so much of our debt? That’s an excellent question, and I’m glad I asked it. Here’s Stephen S. Roach:
China is no innocent bystander in America’s race to the abyss. In the aftermath of the Asian financial crisis of the late 1990’s, China amassed some $3.2 trillion in foreign-exchange reserves in order to insulate its system from external shocks. Fully two-thirds of that total – around $2 trillion – is invested in dollar-based assets, largely US Treasuries and agency securities (i.e., Fannie Mae and Freddie Mac). As a result, China surpassed Japan in late 2008 as the largest foreign holder of US financial assets.
Not only did China feel secure in placing such a large bet on the once relatively riskless components of the world’s reserve currency, but its exchange-rate policy left it little choice. In order to maintain a tight relationship between the renminbi and the dollar, China had to recycle a disproportionate share of its foreign-exchange reserves into dollar-based assets.
Get that? Beijing keeps the renminbi weak by trading all the dollars we send them for US securities. That keeps the demand for the dollar up and demand for the renminbi low. But you probably already knew that. What you might not know is this next bit:
Those days are over. China recognizes that it no longer makes sense to stay with its current growth strategy – one that relies heavily on a combination of exports and a massive buffer of dollar-denominated foreign-exchange reserves.
China has hit a wall: Slumping demand. American consumers are tapped out, and likely to stay that way for some time. Exports are no longer China’s path to riches; now they’ll have to depend on Chinese consumers.
Which means China’s appetite for US debt is about to shrink — regardless of what we do with our budget. We could raise the debt ceiling tomorrow, we could pass a balanced budget amendment the day after that, we could put our nation’s finances on a sound glide path to solvency over the next few years —
— and China still won’t be buying our debt at firesale prices.
We’re sitting on $14.4 trillion in obligations. We’re about to jack that up to $17 trillion, even if Cut, Cap & Balance becomes law right now.
Those $17 trillions we owe, most of it rolls over every few years. It’s mostly short-term obligations. Right now, the vig is about $200 billion each year, at the abnormally-low interest rates China has been willing to accept to feed their export-growth engine.
If Roach is right, if China isn’t going to be the buyer it once was, then who’s going to re-fi our existing debt, and at what price?
And I can’t emphasize this one enough: I’ve outlined the rosy scenario here. It is 99% certain that things will be much, much worse.
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