August 14th, 2011
02:00 PM ET

China's not doing us a favor

By Fareed Zakaria, CNN

What struck me this past week was China's reaction to our credit downgrade. Its state-run media thundered that America needed to "cure its addiction" to debt.

A Hong Kong newspaper widely read on the mainland ran a front page with a banner saying "The American Dream is Over."  It went on to report that Washington owes every single Chinese citizen 5,700 Yuan - about 900 U.S. dollars.

Another editorial said Washington's solution to its debt time bomb was to make the fuse one inch longer.

That kind of commentary has hit a nerve with the Chinese people. After a drop in Shanghai's stock market, bloggers took to local social media sites. One wrote: "The U.S. suffered a downgrade, why did we become the biggest victim?" Another said: "It was a huge mistake to buy U.S. bonds with Chinese taxpayer money. We must hold those who are involved responsible."

Here in the U.S. you hear many people worry that the Chinese government might stop buying American T-Bills. I think these fears are vastly overblown.

The economic situation between China and the U.S. is the financial version of mutually assured destruction - that cold war doctrine of nuclear deterrence. If you destroy me, I will destroy you.

Let me explain. I'll start with the facts. China is indeed America's biggest foreign lender - it owns about 1.2 trillion dollars of debt - more than Japan, the UK and Brazil.

A little-known fact is that most of America's debt - 14.3 trillion and counting - is owned by Americans in Social Security trusts, pension funds, and by the Federal Reserve.

But it is the marginal buyer that matters, so China is important. Imagine that China were to sell off those 1.2 trillion dollars of U.S. Treasury bonds. This is a huge hypothetical - but let's play out the disastrous chain of events that would happen if China began to divest.

It would trigger panic selling of the dollar. That would in turn hurt the U.S. economy, which is China's number one export market (not a good idea if you are the Beijing government trying to keep workers occupied in factories across China).

China is addicted to a strategy of export-led growth, which requires that it keep its goods cheap. This means keeping its currency undervalued. That's why it buys dollars.

But could China stop or slow down its new purchases of American debt? Yes, but even here, it has fewer options than people think. As China's export growth continues, it will keep adding to its foreign reserves of 3.2 trillion dollars. Where can it park that money? Does it want to invest in Japanese debt and make the Yen a reserve currency? Anyone who understands the deep animosity between China and Japan will see that this is unlikely.

Euro-denominated assets are a possibility - but there's really no such thing as European Treasury bonds. And even then, do you really want to put all your eggs in the euro when the future of the currency looks more shaky than ever before? Can you be confident that it will even be around 15 years from now?

As for British pounds and Swiss francs, you can buy those but just not in the vast quantities that China needs given the cash it generates.

And of course, if China were to stop buying Treasuries, the value of the Yuan would rise, Chinese exports would become more expensive and employment in China would fall.

So at the very moment China's bloggers and state-run media were blasting the U.S. government for its profligacy, guess what Beijing was doing?

It was buying U.S. Treasuries.

The reality is that China is trapped into a cycle of buying our T-bonds.  No matter what any ratings agency says, no other bond market is as big or as safe.

So ignore all those theories about China doing America a huge favor. The reality is, they have nowhere else to go. We're probably doing them a favor.

And by the way, in terms of who is paying whom, data from the Congressional Budget Office shows that the U.S. pays out some 74 million dollars to China in interest payments on debt every day. We did the math. That means Washington is paying Beijing 833 dollars every second.

For more of my thoughts through the week, I invite you to follow me on Facebook and Twitter and to bookmark the Global Public Square.

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Topics: China • Debt Crisis • Economy • From Fareed • GPS Show • United States • What in the World?

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