This story appears in the February 9, 2014 issue of Forbes. Subscribe
China's holdings in U.S. Treasurys, which reached record levels in 2013, are setting off alarm bells. They shouldn't. They underscore that Beijing is becoming more dependent on the U.S. and the rest of the world for its strength and prosperity. China's military leaders may not recognize that truth any more than Germany's military, its militaristic Prussian aristocracy (which had outsize influence prior to WWI) and some of its intellectuals did in 1914.
Some points to keep in mind.
--If we and Beijing ever engaged in a mortal confrontation, how much would China's holdings in American government bonds be worth if we said the paper was no longer valid? Beijing is a hostage to our willingness to honor these obligations.
--China has not been a big buyer of our paper for several years because of its concerns about the dollar's integrity.
--Chinese companies get dollars by selling us products that they either made or assembled from corporate global supply chains. Unless China wants to sit on paper money, it will continue to use those dollars to buy stuff from us, in this case government bonds.
--The fact that the Chinese government is amassing so much in foreign currencies--$3.8 trillion at last count--means that China's capital markets are still primitive compared with ours and Britain's. That money is centrally controlled instead of being in the hands of numerous parties--banks, insurance companies, venture capital funds, mutual funds, private companies that wish to invest overseas and so on--that would put it to work creating new products and services. Prior to WWI Britain ran mammoth trade surpluses, which were far greater proportionately than are those of China. But the money didn't sit in the Bank of England collecting interest. It financed a mind-boggling array of railroads, companies and agricultural enterprises all over the world. Private entrepreneurs, not government officials, directed those investments. British capital, for instance, financed much of the industrialization of the U.S.
--What would happen if China, to damage us, decided to dump its trove of Treasurys? Prices might wobble, but not for long. There are trillions of dollars' worth of financial securities scattered around the world, and smart asset buyers would gobble up Treasurys if they thought they were underpriced. Moreover, the Fed, which already has a bloated balance sheet of $4 trillion, could easily absorb what China owns in Treasurys--$1.3 trillion.
--If China did sell Treasurys, it would be paid in dollars. Then what? Would it dump the dollars for, say, yen or euros? The European Central Bank and the Bank of Japan, not to mention the Fed, could take countermeasures if they so desired, to make sure currency ratios didn't get out of line.
The idea that a government gains strength by piling up dollars or other foreign currencies is a mercantilist holdover from the 16th to 18th centuries, when France, Spain and others thought amassing gold and silver was how a country became wealthy. Trade, not hoarding, makes for a powerful economy--an insight Adam Smith understood but one that too many people today don't.
For more from this issue’s Fact and Comment see here: Why Keynes' Quack Money Theories Still Hurt Us Today
