The deep recession and current fiscal policy have produced a large deficit and no sign the flow of red ink will cease any time soon. This makes the U.S. government a major borrower in world financial markets. There is speculation that China, which has acquired a huge amount of U.S. Treasury debt, may soon begin unloading it. Would this pose an important threat to our recovery?
Between December 2008 and December 2009 the amount of U.S. Treasury debt held by the public, including investors in other countries, increased about $1.44 trillion. According to the Treasury Department, a little less than 2% of the additional debt was purchased by government and private buyers in mainland China. Even if we add in the purchases of Hong Kong investors, China’s net purchases of Treasury debt amounted to only a bit more than 7% of new debt issued by the U.S. government. The most important net purchasers of Treasury debt were Americans (63% of the total), the United Kingdom and its residents (12%), and Japan and its residents (10%). Thus, China does not appear to have been a crucial buyer of Treasury securities for the past year or so.
Of course, China could sell off some of its enormous reserves of U.S. Treasury securities. It currently owns almost 10% of the total Treasury debt held by the public. This is slightly less than the percentage held by Japan and residents of Japan, but substantially more than the percentage held by any other country. I’m inclined to think a Chinese sell-off of U.S. Treasuries would on balance benefit the United States. One reason China has accumulated such large reserves is that it has sought to maintain a low value of its own currency, primarily to help maintain a competitive edge in export markets. This policy has helped make China one of the world’s great exporters, but it has also hurt workers and producers in the United States and other countries. If the dollar fell in value compared with other currencies I think we would see a faster U.S. recovery, especially in manufacturing. A precipitous and disorderly fall in the dollar could take a terrible toll on worldwide confidence and hence on the economic recovery, but an orderly decline would spark revival in a number of U.S. industries.
An important barrier to a dollar decline is China’s policy of maintaining a low value of its own currency. A sizeable sell-off of Treasury securities by China would almost certainly lead to an appreciation of China’s currency and depreciation of the dollar. This is more likely to help the United States than to hurt us, contrary to the claims of many observers. To be sure, the U.S. government would have to pay somewhat higher interest on its debt, but it seems likely the gains to the U.S. from faster net export growth would greatly outweigh the losses from higher public borrowing costs.