Everything You Know About Economics Is Wrong: China Doesn’t Own The United States

Most people assume China “owns” the US because it holds so many of our Treasury securities.  Both China and Japan each own over $1 trillion of the $22 trillion US Treasuries outstanding. Investors are always worried about what will happen to US interest rates when either country decides to sell, or, even worse, stops buying US Treasuries altogether.

But these fears are misplaced. We do not need China and Japan to finance US Government spending.  In terms of foreign buyers of our Treasuries, it’s important to remember four things.

First, the government doesn’t need to issue Treasuries to raise revenues. It can just print the money. The US is not beholden to China to finance our spending. The government is nice enough to pay foreign holders of our currency some interest but it doesn’t have to in order to maintain the value of the currency. That’s because the value of our currency is determined by US tax policy. As long as the US government demands US dollars to relieve tax obligations, our currency will have value.

Second, the US cannot go bankrupt since it has a printing press. The risk of default is 0%. If foreign holders of Treasuries sell their securities because they believe the US is going to default or devalue its currency, then you should buy them because that is not going to happen.

Third, the short term interest rate is set by the Federal Reserve. Since the Federal Reserve controls short term interest rates, there is no market signaling going on at the short end of the yield curve. The market can reflect its displeasure by selling longer-term treasuries but the short-term rates are fixed. And if the Fed wants to artificially lower long term rates, it can do so by buying those long term securities as Ben Bernanke did with Quantitative Easing.

Finally, US dollars never leave the US financial system. Unless a foreign entity takes a cash payment and transports it overseas, money never leaves the US system.  When the US Government buys something from a foreign entity, that money is deposited in a bank account.  All banks, even international banks, have an account at the Federal Reserve.  So if the dollars stay in the bank account, they just go into the Federal Reserve’s excess reserve account.

If, on the other hand, the foreign entity wants to earn more interest, they can purchase Treasury securities, which are also held in an account at the Federal Reserve. Either way, the money stays at the Federal Reserve, which is an agency of the US government. The only difference between holding money in a bank account and holding money in Treasury securities is that the US Government pays interest on the Treasury securities. 

So rest easier at night.  The Chinese aren’t going to destroy the US financial system any time by simply selling their Treasury bonds.

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