Matt Yglesias points out correctly that Chinese ownership of American debt doesn’t give them the ability to repossess, thereby refuting a John Stewart joke.
But while massive foreign ownership of American debt doesn’t give foreign powers the “right” to take over the country (nor the ability), it does give them considerable leverage over the policies of the United States government.
That’s because the debt has to be rolled over. We’re not going to pay it off. We shouldn’t want to pay it off. (Ever.) So when it comes due, we’ll need to sell new debt to pay off the old principal. And that new debt will pay interest at then-prevailing rates. We need buyers of American debt in large numbers to exist in the future, or we won’t be able to roll the debt over at attractive rates (which means we’ll be paying more in taxes to service the debt).
Now, this would all be true whether the buyers of government debt are domestic or foreign. But if the buyers are domestic, then the whole “tax to pay interest” thing is a domestic redistribution question: who is to be taxed to pay interest to whom. There are a variety of ways to settle these kinds of questions, but none of them have direct foreign policy implications.
But if the debt is held substantially by foreign powers, then higher interest rates mean paying more taxes to those foreign powers.
Our dependence on foreign debt purchases is rather like our dependence on foreign oil. Because we consume so much oil, cannot easily switch to other fuels, and purchase so much of it abroad, we have an interest in places like Saudi Arabia. And these countries do have some ability to influence our foreign policy – more than they would have if we were an oil exporter or if we used nuclear fusion to meet our energy needs. Similarly, if China is the overwhelmingly dominant buyer of American federal debt, then China’s decisions about what the right price is for that debt – what interest to demand – will be the most important factor in determining what the price actually is. And that gives them leverage over the United States government.
Yglesias wonders all the time why we have such a pronounced policy preference for disinflation, across both parties, even when inflation has been below target and unemployment has been really high. There are a variety of reasons – the fact that the ECB is even more paranoid about inflation, for example; the fact that unemployment isn’t afflicting a true cross-section of the American public; the vastly expanded political influence of the financial sector – but I’ve long felt that one reason is that we have to keep the Chinese happy because we need them to keep buying our debt. Let’s put it this way: when was the last time you heard a Chinese official say that America needs to do more quantitative easing to spur growth, because they are worried that too much austerity will impair our ability to pay back the debt they own? Never? Correct. Because the odds of truly defaulting on our debt are virtually zero, never mind the current Washington shenanigans, whereas the odds of inflation eating away at the value of the debt owned by the Chinese are to some extent positive. Disinflation-above-all is the preferred policy for somebody who is a substantial creditor to the United States and in no sense an equity holder.
Yglesias thinks it would be better for the Chinese to buy less American debt. I agree, although the way I would put it is that it would be better for both the Chinese and the Americans for China to raise its level of domestic demand and lower its savings rate. But this would require Americans to generate more savings to compensate, otherwise interest rates would go up, making rolling our enormous debt more expensive. And raising savings rates is contractionary. There’s not a way around this. Many of the things we need to do for the long term health of the country – for example, reducing our dependence on fossil fuels and reducing our dependence on foreign credit – are contractionary in the short term. Goosing inflation expectations will lower domestic savings when we need to be raising it. Goosing demand will increase demand for imported oil when we need to be reducing it. What Yglesias thinks is the optimal policy response to the tragedy of persistently high unemployment – namely for the Fed to engineer higher inflation expectations to boost domestic demand – digs us further into our long-term hole. Higher domestic demand means lower domestic savings which means an increased dependence on Chinese purchases of domestic debt. Higher inflation expectations mean higher long-term interest rates (which means more of our taxes going to pay interest, and less to providing services to the American people) or, if interest rates remain low, that implies that higher inflation expectations are being offset by lower real growth expectations, and it’s real growth that makes us wealthier.