CHINA'S SUBSTANTIAL HOLDINGS OF U.S. government debt and the creation of a sovereign wealth fund (SWF) are causing concern that U.S. economic and national security may be at risk. Rapid economic growth, record current account surpluses, and a high domestic saving rate have allowed China to accumulate more than $1.5 trillion in foreign exchange reserves, much of which is invested in U.S. government securities. This article examines the political and economic implications of China's rising share of U.S. public debt, and asks whether foreign-held debt is a real threat to U.S. prosperity or an excuse for economic nationalism.
CHINA AND THE GROWTH OF FOREIGN-HELD U.S. PUBLIC DEBT
The United States must borrow from foreigners and sell them assets in order to finance the excess in U.S. domestic investment over domestic saving. At the same time, U.S. government budget deficits have added to the U.S. debt. Current private and government consumption, relative to gross domestic product (GDP), has been sustained only because foreigners have been willing to hold U.S. Treasury securities and invest in U.S. assets. The massive amount of dollars held by foreign central banks, which mostly end up being invested in U.S. Treasury and other government securities, has kept U.S. interest rates lower than otherwise and allowed U.S. domestic investment to exceed domestic saving.
In January 2008, the public held $5.1 trillion of outstanding U.S. Treasury debt while intragovernmental holdings (for example, by the Federal Reserve and the Social Security "trust fund") amounted to $4.1 trillion. The total national debt of roughly $9 trillion does not include the trillions of dollars of unfunded liabilities in Medicare and Social Security that need to be met in the future.
Of the publicly held Treasury debt, foreigners now account for 44 percent, compared with 37 percent in 2003. Between 2003 and 2006, foreign ownership of U.S. Treasury securities increased from $1.4 trillion to $2.13 trillion-an increase of nearly 50 percent. What worries Congress is that China, the world's largest communist country, now holds nearly 20 percent of the total foreign-held Treasury debt (more than $400 billion) and is acquiring more than 50 percent of net new issues.1 In addition, foreign investors held $1.2 trillion in U.S. agency debt and government-sponsored enterprise securities at the end of 2006, more than double the amount held in 2001. China is now the largest holder of that debt with 23 percent of the total in 2006.2
Because the United States is living beyond its means-that is, spending more than its income-the gap between domestic saving and investment is reflected in an increase in net foreign claims on the United States (Figure 1). Those claims went from $9 trillion in 2000 to $13.6 trillion in 2005, an increase of 52 percent. Of that total, 17.4 percent represented foreign-held U.S. government (Treasury and other agency) debt, with most of that debt being held by foreign central banks rather than private investors.
The rise in foreign-held U.S. Treasury debt and the overall increase in claims against the United States are causing concern that the United States may end up being heavily indebted to oil-rich nations and to non-democratic countries like China, and that foreigners may end up owning a large chunk of the United States.
In particular, Congress is worried that China could use its large holdings of U.S. government debt to gain political leverage by threatening to dump those securities if the U.S. threatens to enact protectionist measures against China or to intervene in relations between the mainland and Taiwan. Washington is also concerned that the increasing economic power of China will be used to edge out the United States as the dominant power in Asia.
Even though China only accounts for about 25 percent of the U.S. overall current account deficit of around $800 billion, many in …