When people talk about how the US government finances its spending we often hear that we are dependent on China to finance our spending. This story, however, is not usually put in the right perspective so I will try to clarify some of the mistakes people make.
First, to understand why China buys US bonds you have to understand why China has such voracious demand for those bonds. China runs a trade surplus with the USA which means that they export more goods than they import. This can also be described as a US Dollar surplus which means that China imports more US Dollars than they export Yuan to the USA in exchange for these goods. As a result of this the Chinese economy ends up with a surplus of US Dollars that they will desire to utilize somehow. A large portion of these Dollars simply get reinvested in safe assets like US T-Bonds. So the fact that China buys US T-Bonds is really a function of China’s trade surplus with the USA. So, as long as China wants to maintain this beneficial relationship with the USA they will inevitably have surplus Dollars that need to go somewhere.
Additionally, as a percentage of overall debt, China represents only about 7% of all outstanding US Treasury Bonds. This isn’t an insignificant amount of ownership, but it is hardly an amount so large that they could throw the US bond markets into turmoil if they decided to stop expanding their ownership. But again, it’s important to remember the true source of demand there – US consumers are sending Dollars to China which is then leading to the demand for T-Bonds. So, if China wants to stop buying T-Bonds they will really need to alter their trade relationship with the USA. Considering that China benefits tremendously from this relationship there is no rational argument that China will halt demand for US T-Bonds.
Lastly, demand for US T-Bonds is high because the US Dollar is the dominant reserve currency in the world. While it is accurate to say that China “funds” US government spending to some degree the US government is not dependent on demand from China to sell the world’s safest bonds. The idea that there would not be demand for these bonds from other market participants, were China to stop buying bonds, is simply wrong. In fact, we’ve seen periods in the past where China reduced their demand for T-Bonds and there was little or no impact on the US bond market.
The fears over China’s ownership of US debt are largely exaggerated and I think a more objective look at this situation helps put things in the right perspective.