China has become a formidable economic powerhouse. It has, moreover, not seemed to be willing to play fair, with the government influencing trade through monetary manipulation, subsidies, and tariffs. It has become the 800 pound gorilla that seems to be on everybody’s mind.
One of the features that seem to be especially troubling for some people is the fact that China owns a substantial amount of United States government debt. Because they also possess a powerful military force and an authoritarian, power-seeking government, there is a plausible threat that they can use their debt holdings to hold America hostage by threatening to refuse to roll over the debt as it comes due. It is true that, should that happen, there would be some level of turmoil, not just in the American economy, but elsewhere throughout the world.
To put things in perspective, the United States national debt stands at around 21 trillion dollars. China owns about $1.2 trillion of it, about 5%. Federal agencies, such as Social Security Trust Fund and other pension funds, hold about $6.5 trillion. Foreign governments and organizations, including China, own about $6 trillion. The Federal Reserve Bank owns $2.5 trillion. The rest is owned by private pension funds, mutual funds, insurance companies, banks, and private individuals.
$1.2 trillion dollars is a lot of money, and people have made the mortgage analogy, that just as a bank can foreclose on your mortgage for non-payment, China could foreclose on a United States debt default. The difference is that, with a private mortgage, the bank has a legal right to repossess the home if you don’t pay what is due. Debt of the federal government, however, is backed by nothing but the full faith and credit of the United States. There are no assets that can be legally seized.
That doesn’t mean that there would be no negative effects of a default. They would, in fact, be quite devastating. United States debt has a very low interest rate because it is viewed by investors as very safe, nearly a guarantee of payment when due. A default on debt would scare all investors away and the government would have to offer very high interest rates and some sort of guarantees in order to raise money. The government definitely does not want to default.
The real issue, however, is not what would happen if the United States defaulted on the debt owed to China, but rather what adjustments would need to be made to absorb the debt should China suddenly decide not to roll over the various debt instruments as they become due. Default is a very unlikely scenario.
If China demanded payment on the debt instead of buying new issues, the money would have to come from somewhere. The only likely source for that kind of money is the purchase of new debt by other investors. It could be that the Treasury would likely have to increase the incentives to buy by increasing the rates, but if there was a threat of a major economic disturbance, there is another option. The federal Reserve Bank is already a major holder of the securities, mostly because of the prior stabilization efforts. One of the stated objectives of the Bank is to stabilize the economy, so if there was a lot of unsold debt obligations lying around that would cause disruption, it is likely that the Federal Reserve would buy up what was needed to prevent default and destabilization.
Therefore, the China debt and default can be taken off the list of bogeymen. Whew! One more thing we can stop worrying ourselves about.