In his first campaign for the presidency, Barack Obama highlighted the U.S.’s difficulties with promoting American interests in Asia. The most imposing obstacle? China’s fiscal influence throughout the continent articularly lamenting China’s fiscal influence. “It’s pretty hard to have a tough negotiation,” Obama complained, “when the Chinese are our bankers.” (1)
At the time, the People’s Republic of China (PRC) held well over $1 trillion in U.S. government debt, with some estimates even ranging up to $1.7 trillion (2). While that number has dipped to $980.8 billion dollars as of October 2022, China’s holdings of U.S. government debt are still some of the largest in the world (3). China’s massive share of U.S. government debt effectively confers serious influence over American policy making. Moreover, as China competes with the U.S. for global influence (particularly in the Taiwan Strait), their financial authority serves as a particularly potent weapon for the PRC in seeking to supplant the U.S. as the world’s hegemon. Yet as the global economy enters a period of turbulence, and the American economy teeters on recession, China’s financial leverage is bound to be weakened, thereby threatening the PRC’s greater hegemonic ambitions as well.
Why does China own so much of the U.S.’s debt? In essence, because it is beneficial for the Chinese economy. China’s large volume of U.S. treasuries purchases help stimulate consumption in the American economy, which in turn increases Chinese export sales to the U.S. In addition, Chinese loans allow the U.S. to run persistent budget deficits and continually commit to high rates of government spending (i.e., an expansionary fiscal policy), invigorating American economic activity as a result. Of course, massive spending bills, lower tax rates also contribute to the U.S.’s budget imbalance. Nonetheless, since the U.S. is the largest importer of Chinese goods, the PRC naturally stands to benefit from strong economic activity in the U.S (4).
As China and the U.S. have grown closer as trade partners, Chinese holdings of U.S. debt have ballooned. And as mentioned earlier, China’s status as a large creditor to the U.S. provides the PRC with significant political leverage over American policy making. A Chinese sell-off of American debt would hinder the U.S. to continue to commit to high levels of government spending. As a result, the U.S. would be forced to restrain its fiscal policy by either reducing its budget deficits, or by selling U.S. treasuries to other countries. However, the feasibility of both these solutions is questionable. The dollar’s value is currently riding strong as the U.S. Federal Reserve has hiked interest rates to tame inflation, making it an expensive investment. The U.S. would thus experience trouble finding willing states to purchase American debt. Similarly, it is unlikely the U.S. would significantly reduce their budget deficit, since it would require further economic austerity measures, which would be challenging politically for the Biden administration. However, what is certain is that both of these solutions would slow economic activity in the U.S. This means China can levy the threat of sell-off whenever American policy conflicts with their goals. For instance, China’s recent reduction of U.S. debt in July of 2022 dropped their holdings to their lowest level in 12 years, which analysts argue was motivated largely by the U.S.’s exclusion of Russia from the SWIFT international banking system (5).
However, many disregard the notion that China’s share of U.S. debt confers political leverage to the PRC. Instead of a coercive instrument, analysts emphasize the degree of China’s ownership of American foreign debt as a mere reflection of the interconnectedness of the two economies.This approach states that China could not threaten a wholesale sell-off of its U.S. debt holdings, contending their sheer scale would have negative consequences for the Chinese economy itself. Thus, why worry about China’s fiscal influence over the U.S., or even portend its weakening as a result of the global economic downturn?
While China and the U.S. may share a very close economic relationship, the aforementioned attitude ignores not only the diametrically opposed political orientations of both nations, but also that they are both engaged in competition for global hegemony. This is particularly exemplified in the controversy of Taiwan’s sovereignty. If the U.S. is reliant on the PRC’s purchasing of American debt to maintain strong economic performance, China can leverage this to deter U.S. policy which conflicts with their aims to reincorporate Taiwan with the mainland. Though it did not force the U.S. to reverse its policy, China’s debt reductions after the U.S.’s exclusion of Russia from the SWIFT international banking system exhibits the execution of this threat clearly. Furthermore, China need not threaten a complete sell-off of its American debt in order to influence the U.S.’s actions if the PRC did attempt to reincorporate Taiwan through military means. Small but significant reductions would still be capable of forcing the U.S. to reevaluate its policy by inflicting severe enough damages for the U.S. to sustain. Thus, it is misguided to assume that China’s status as a significant creditor of American debt does not threaten the U.S.’s position as the world’s predominant power.
However, the global economic downturn poses a serious hazard to the potency of China’s fiscal influence over the U.S.. As previously mentioned, projections for the U.S. economy in 2023 are characteristic of recession, with the U.S. Federal Reserve predicting GDP growth to grind to 0.5% in 2023 and unemployment to rise (7). Additionally, the Conference Board, a nonprofit think tank, expects that the American economy will experience three consecutive quarters of negative economic growth beginning in Q1 2023 (8). Similarly, the U.S. Federal Reserve’s efforts to tame inflation through restrictive monetary policy will tighten the American money supply, further contributing to a sluggish economy.
Decreased economic activity in the U.S. will naturally harm China by reducing demand for Chinese goods in the U.S., a worrying trend the PRC is already facing globally (9). Consequently, China’s massive investment in U.S. debt will not yield equally substantial returns as poor economic conditions affect American consumption. The severity of the economic downturn will harm China despite their past financing of strong activity in the U.S. economy. In turn, this will render the PRC’s holding’s of U.S. debt as less consequential to American economic performance and thus reduce the political influence attached to China’s large share of U.S. Treasuries. This is particularly true in the event tensions escalate further over Taiwan as they are expected to do. If their financing ceases to significantly contribute to a strong U.S. economy, then the PRC only wields empty threats. Thus, how can China expect the U.S. to flinch if it threatens to decrease its holdings of American debt in the event of a clash over Taiwan?
It should be noted, however, that the American economy is expected to rebound in 2024, along with the rest of the global economy (8). Nevertheless, global economic turbulence will leave scars on China’s fiscal influence, and with it consequences for the nation’s goals of global hegemony.
Citations:
- Oatley, T. (2019). International political economy. Routledge, Taylor & Francis Group.
- Stetser, B. W. (2009, February 26). Who bought all the treasuries the US issued in 2008? and who will be the big buyers in 2009? Council on Foreign Relations. Retrieved March 14, 2023, from https://www.cfr.org/blog/who-bought-all-treasuries-us-issued-2008-and-who-will-be-big-buyers-2009
- Sebastian, A. (2023, February 7). 5 countries that own the most US debt. Investopedia. Retrieved March 14, 2023, from https://www.investopedia.com/articles/markets-economy/090616/5-countries-own-most-us-debt.asp
- China Trade. China Trade | WITS Data. (2020). Retrieved March 14, 2023, from https://wits.worldbank.org/CountrySnapshot/en/CHN
- Jamali, L. (2022, July 19). Why is China reducing its U.S. debt holdings? Marketplace. Retrieved March 14, 2023, from https://www.marketplace.org/2022/07/19/why-is-china-reducing-its-u-s-debt-holdings/
- Is it a risk for America that China holds over $1 trillion in U.S. debt? China Power Project. (2020, August 26). Retrieved March 14, 2023, from https://chinapower.csis.org/us-debt/
- Schneider, H. (2022, December 20). Recession, or recession-ish? Fed outlook for U.S. walks a fine line. Reuters. Retrieved March 14, 2023, from https://www.reuters.com/markets/us/recession-or-recession-ish-fed-outlook-us-walks-fine-line-2022-12-16/
- The Conference Board Economic Forecast for the US Economy. The Conference Board. (2023, February 15). Retrieved March 14, 2023, from https://www.conference-board.org/research/us-forecast
- China balance of trade February 2023 data – 1981-2022 historical – March forecast. China Balance of Trade – February 2023 Data – 1981-2022 Historical – March Forecast. (2023). Retrieved March 14, 2023, from https://tradingeconomics.com/china/balance-of-trade
