Role of China in US Debt Crisis
Article Summary
James Dorn (2013) has described the pressures within China that force it to hold a substantial proportion of US debt. Dorn proposes measures to ease the internal fiscal pressures of China so that global financial stability and harmony can follow (Dorn).
China holds 8.4 % of the US gross public debt. The Chinese holdings of US Treasury bonds are, however, only the consequence US debt, not the cause. The real cause of US debt is overspending and excessive entitlements in Medicaid and Medicare. However, the financial repression of the Chinese economy has had an impact on the US debt crisis (Dorn).
Chinese capital markets are tightly controlled by the state. The government sets the rates for deposits and loans. State control limits avenues for investments, making the financial markets inefficient. Political controls offset whatever little progress China is attempting to make by easing capital controls and liberalizing interest rates (Dorn).
China seeks to protect its export potential by undervaluing its currency. To keep its currency undervalued, the Chinese government has to buy US dollars at the pegged rate of the Chinese Renminbi. Increasing interest rates runs the rick of capital inflows. So, China resorts to administrative controls and credit quotas (Dorn).
The USA is caught in a bind with Chinese holdings of its debt. If China were to allow its currency to be market-determined, the demand for US debt would decrease, and USA would have to set its financial house in order. This aspect is not palatable to policy makers (Dorn).
China could release it stranglehold over US debt in a gradual manner. China’s foreign exchange reserves tied in US debt have prevented private sector investments in China, while at the same time funded profligate policies in USA. If China’s holdings of US debt decreased, Chinese capital would return to the mainland in private hands. Domestic investment would spur the service sector and herald a private, market driven economy in China. This would be a desirable alternative to the current situation, where both China and the USA have moved towards the Left in political orientation because of the capital imbalance existing between China and USA (Dorn).
The USA has to curb public debt due to over-consumption, high marginal tax rates on capital, low savings rates, leveraged financial sector, rising healthcare costs and over-regulation due to an unwieldy government. China, on its part, has to allow private free markets. China could normalize the balance of payments by letting nominal rates adjust freely to market forces and increasing factor productivity (Dorn).
Beijing is alive to the fact that it cannot leverage US debt any further without risking a collapse in the US financial system. It has taken steps for setting up economic zones and allowing banks to offer loans at upto 20% lower rates than the benchmark rates (Dorn).
China’s notion of a ‘harmonious’, state driven society is unsustainable. To rebalance its economy and usher in global peace, the state power would have to be curtailed and private property, freedom of contract and rule of law strengthened (Dorn).
Conclusion
China and USA are intricately linked in a global balance of payments. USA could hurt China by devaluing its currency. China could hurt USA by calling in its debt. Both countries need to be sagacious while negotiating a withdrawal from the current positions. USA needs to become more fiscally responsible. China needs to encourage private capital and work towards a gradual reduction of state control over the capital markets.
Work Cited
Dorn, James A. “The Role of China in the US Debt Crisis.” Cato Journal 33/1 (Winter 2013): 77-89. Web. 26 Nov 2015.
