The fact that China holds trillions in US treasuries (bonds) poses little-to-no economic threat to the United States. If China decided tomorrow to “dump their debt” (which means to cash in or redeem all their treasuries), it would harm China and not harm the US. Why this is true requires understanding the nature of bonds, and the transactions by which they are bought and sold. This post provides a detailed walkthrough.
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This post was last updated September 18, 2020. Disclaimer: I have studied MMT since February of 2018. I’m not an economist or academic and I don’t speak for the MMT project. The information in this post is my best understanding but I don’t assert it to be perfectly accurate. In order to ensure accuracy, you should rely on the expert sources linked throughout. If you have feedback to improve this post, please get in touch. |
[Extra disclaimer: I have much to learn. The overall point I’m trying to make I believe to be correct, but I expect some of the details are not. This document will be updated as necessary.]
China sells products to the US and receives US dollars in payment. More precisely and most often, Chinese companies sell their products to American companies, who then sell some of them to American consumers. The dollars received by Chinese sellers are not sent to China (dollar bills in suitcases are a very small part of the picture). Rather, the sellers have accounts in American banks, which in turn have reserve accounts at the central bank. (In the US, the central bank is called the Federal Reserve).
Let’s back up for a moment:
You have money in a checking account at your local bank branch. It earns no (or little) interest, but you can spend it immediately and directly (meaning it’s liquid). You can also open a savings account. At that point, a new account is opened in your name and some of the money from your checking account is transferred into it. The savings account earns some interest, but in order to spend it, it must be first transferred back to the checking account (it’s less liquid).
Banks (and foreign entities, or agents) have reserve accounts at the central bank. A reserve account is nothing more than a checking account for banks: the funds are liquid and pay little-to-no interest. With one exception, Treasury bonds (held at the central bank or Treasury) are no different than a savings account: less liquid but earn interest. The exception is that bonds also have an amount of time before they can be redeemed. This is how long it takes to mature (such as between three months and thirty years), and is called its term. In many cases, however, there is nothing to stop a bondholder from selling their bonds to someone else before maturity.
(For more details on the bond market, listen to the 9/2019 episode of MMT Podcast with University of Adelaide economics professor Steven Hail: parts one and two.)
Purchasing a bond is therefore no different than opening a savings account. Redeeming a bond is closing that savings account, with the funds once again becoming reserves. In other words, both purchasing and redeeming bonds is nothing more than an asset swap – that is, an even exchange. (Related post: Sovereign governments don’t borrow, they *securitize*.)
To put it more concisely: Purchasing a bond is an even swap of money that doesn’t make money, for money that does make money. Selling a bond is the same thing in the opposite direction. (This turn of phrase comes from Christian Reilly, who is the co-host of MMT Podcast.)
China!!!
As of mid 2020, the Chinese government owns around $1 trillion in Treasuries, which is less than five percent of the total outstanding US treasuries (which by definition is the national debt of the United States). Much more is held by rich Chinese citizens and corporations. If China were to “dump all its debt,” then, first of all, the government would have to coordinate this with all its rich citizens and corporations. Assuming they did this, then they would all inform the US to redeem all their matured bonds. The funds for those bonds would be transferred back into their reserve accounts. The only effect of this action would be to eliminate their steady stream of interest income. They still have the same amount of money.
For those bonds that have not yet matured, China would sell them on the open market to other countries (or agents in those countries). Flooding the world market in this way would cause their (secondary/market) prices to decrease, at least for a time. This means that, in addition to losing interest income, China would also substantially lose out in the prices other countries are willing to pay.
(As far as this action negatively affecting United States interest rates, this will only happen as far as the voting members at the central bank allow it to. The interest rate is a policy variable of those voting members [which in the US is the FOMC board at the Federal Reserve]. See Scott Fullwiler’s 2020 paper, zzz )
No matter what, however. although some dollars may have changed ownership, the total number of dollars in the world economy remains unchanged. To be perfectly clear, the only entity on earth that can create and destroy US dollars (and treasury bonds), is the United States government. Further (and setting aside the suitcases of cash), every dollar and treasury in the world is held in a computer at the central bank or Treasury in the United States. China “dumping their debt” would be no more harmful to the United States, than your local bank branch closing out every savings account they have and moving the funds to checking accounts.
Finally, were China to dump all its debt, doing so would also harm China in another way. The Chinese yuan is partially pegged to the United States dollar. This means the Chinese government must “manage” its dollar holdings in order to ensure a reasonable value of the yuan versus the dollar (the yuan-dollar exchange rate). This is necessary in order for Chinese companies (that sell products to the US) to remain profitable. If China sold their entire holdings of US bonds, they would lose control over their own currency which would provide an outsized advantage to the US in terms of trade – especially because the US dollar is not pegged to any other currency. (Related post: The MMT view of developing nations and financial sovereignty.)
Therefore, the idea that China holds economic sway over the United States because of their large holdings of US treasuries, is false.
More information
I discuss the basics of this topic on a May 2020 appearance on Franc Analysis: China debt myths debunked (it comes from this full video which provides an overview of MMT.)
Here’s a brief explanation from MMT founder Warren Mosler, which also addresses the question, “what could China do with all that cash?”:
Another explanation by MMT trader Mike Norman:
Finally, the United States government issues the US dollar. It doesn’t borrow its own money from China – nor for that matter, its own citizens. The idea is silly: “Hey, China, can you please lend us some of our own dollars, so we can make an even stronger military and financial system, so we can turn around and defeat you?” (Listen to the first minute of episode 3 with Geoff Ginter and Ryan Mathis.) (Related post: Sovereign governments don’t borrow, they *securitize*.)
Here’s Mike Norman again with a more general take on the topic of borrowing and China (related post: Central governments don’t borrow, they *securitize*.):
With thanks to various members of Facebook/Intro to MMT – Modern Monetary Theory
Top image flag from mayns82 on Pixabay (license)
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