China Owns US Debt, but How Much? | Investopedia

It seems like every American politician and talking head is concerned by the huge amounts of debt that the U.S. government owes Chinese lenders. The Chinese do own a lot of U.S. debt -- $1.10 trillion as of July 2017.

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Breaking Down Ownership of US Debt

By mid-2017, the total amount of official debt owed by the federal, state and local governments was more than $19.4 trillion. That figure is expected to reach at least $20.2 trillion by the start of 2018. Some experts add more than $120 trillion in unfunded future liabilities on the federal government balance sheet.

Of the $19.8 trillion in government debts, more than $5 trillion (a little less than one-third) is actually owned by the federal government in trust funds. These are accounts dedicated to Social Security, Medicare and other entitlements. In other words, the government wrote itself a really big IOU and bankrupted one account to finance another activity. IOUs are formed and financed through joint efforts of the U.S. Department of the Treasury and the Federal Reserve.

Much of the rest of the debt is owned by individual investors, corporations and other public entities. This includes everyone from retirees who purchase individual U.S. Treasurys to the Chinese government.

China spent the last months of 2016 selling debt and calling in loans, decreasing its total to less than $1.10 trillion. Japan then took the top spot among foreign creditors at $1.11 trillion, though only by default, as the country decreased its holdings of U.S. debt by about $23 billion.

Japan and China each own about 5.5% of the national debt. Japanese-owned debt doesn't receive nearly as much negative attention as Chinese-owned debt, ostensibly because Japan is seen as a friendlier nation and the Japanese economy hasn't been growing at an 7% clip year after year.

Why China Owns So Much US Debt

There are two main economic reasons why Chinese lenders bought up so many U.S. Treasuries. The first and most important is that China wants its own currency, the yuan, pegged to the dollar. This has been common practice for many countries ever since the Bretton Woods Conference in 1944.

A dollar-pegged yuan helps keep down the cost of Chinese exports, which the Chinese government believes makes it stronger in international markets. This also reduces the purchasing power of Chinese earners.

Dollar-pegging adds stability to the yuan, since the dollar is still seen as one of the safest currencies in the world. This is the second reason the Chinese want Treasurys; they are essentially redeemable in dollars. China drew some headlines in 2013 and 2014 for buying up a lot gold to store in its bank vaults, but the real safety net for the yuan is the worldwide belief in the dollar.

Consequences of Owing Debt to the Chinese

It's politically popular to say that the Chinese 'own the United States' because they are such a huge creditor. The reality is very different than the rhetoric.

While 5.5% of the national debt isn't exactly insignificant, the Treasury Department has had no problems finding buyers for its products even after a rating downgrade. If the Chinese suddenly decided to call in all of the federal government's obligations (which isn't possible, given the maturities of debt securities), it is very likely that others would step in to service the market. This includes the Federal Reserve, which already owns more than twice as much debt as China.

Second, the Chinese rely on American markets to buy Chinese-produced goods. Artificially suppressing the yuan has made it difficult for a growing Chinese middle class, so exports are needed to keep businesses running.

Consider what the current arrangement means: The Chinese buy up dollar bills in the form of Treasurys. This helps inflate the value of the dollar. In return, American consumers get cheap Chinese products and incoming investment capital. The average American is made better off by foreigners providing cheap services and only demanding pieces of paper in return.