China has all our debt!

OH NO! But not really.

A lot of people are concerned with China owning so much of our country's debt. What if they make us pay it back all at once? Well they can't do that, and frankly, they don't want to. But there is reason to be concerned, or at least, to understand what it means that China owns so much of our debt.

First we must ask, how did they get that debt?

This is partially tied in with 'globalization' or cheaper labor costs in developing nations and relatively cheap transportation costs. China can manufacture goods more cheaply the United States can because China has been taking advantage of lower labor costs and labor standards to grow its economy, but it needs someone to sell it goods to. Domestic demand in China isn't enough to help it grow as much as it has, it needs a buyer abroad. That's where we come in. The U.S. has run a trade deficit (imports>exports) for a few decades now, and recently much of those exports have been coming from China.

When the U.S. gets goods from China, it sends its dollar to China. We get the goods we want, they get the dollars they want. Now they have excess dollars that they can either: A) convert to Renminbi (the Chinese currency), B) leave as US dollar cash, C) buy goods for sale in Dollars, or D) buy US bonds or other financial assets.

(A) causes appreciation of the Renminbi which China doesn't want, because it makes their goods more expensive relative to the rest of the world causing a decrease in their exports. They really want and need to be an exporting nation to grow fast enough to catch up to the US and Europe.

(C) also hurts their trade surplus (exports>imports) because now they are importing American goods with their dollars.

(B) allows them to hold down the value of the Renminbi (some think this is currency manipulation), but they earn nothing on those dollars and in fact lose value through inflation.

(D) allows them to hold down the value of the Renminbi and they earn interest on whatever the US Treasury is paying on its bonds.

If they cash in their treasuries (by selling them) they are back to holding cash and then have to choose A, B, C, or D. They will not change interest rates on US debt by doing so, because that is mostly controlled by the Fed.

So China takes the dollars they get from exporting goods to us and buys bonds with them to maintain their trade surplus and earn interest on their US financial assets. Their dollars essentially go from a checking account at the US Fed, to a savings accounts at the US Fed.

China cannot manipulate our interest rates with their US debt holdings, because interest rates are controlled by the Fed. Paying interest to China does increase their holdings of US financial assets (cash and bonds) but this acts to increase the supply of dollars, depreciating the dollar, which is basically trying to correct the trade imbalance. China is doing what it can to hold down the value of the Renminbi, because if it goes up they lose their trade surplus.

Really the only thing concerning to me is that Chinese capitalists will use their excess dollar assets to buy American assets like businesses, stocks, bonds, etc.

China can't destroy our economy holding our debt, but they can buy more of our assets if we continue to have a trade deficit.

US government spending isn't the culprit, then, it is rather the large trade deficit. US gov't spending could ameliorate this with a larger deficit, because this would act to depreciate the dollar, making it tougher for China to maintain their trade surplus.

For more on this process I recommend this by Warren Mosler: So how do we pay off China? (go to p. 23-24 of the pdf, 36-40 of the book)