U.S. Debt and the Chinese Government: A Match Made in Purgatory?

BY Elizabeth Shell  November 11, 2010 at 3:39 PM EDT

The United States is in debt to the tune of $13.7 trillion.

But for what, and to whom?

Making SenseAt its core, the debt is the result of more spending than saving at every level, from individual households to businesses to the government. And if the U.S. imports more than it exports (which we do), then debt — or IOUs — is relied on to pay for those imports.

It’s also how administrations have financed the operating and running of the country beyond what tax dollars — and interest payments and a few other financial tools — can cover. This includes everything from trade to international aid programs to defense to Social Security and Medicare.

This is nothing new. Even in its infancy, the U.S. owed tens of millions due to the costs of the Revolutionary War.

The largest portion of the debt is held by Federal Reserve Banks. But what has some analysts and politicians worried is the largest foreign holder: China.

The following graphic by Joshua Ritchie at Mint shows where U.S. debt is held, both domestically and by foreign groups.

And all eyes are on Chinese and U.S. currency and monetary policies this week at the G-20 Summit.

The Treasury estimates China holds around $868 billion worth of our debt. And as Paul Solman will explore in Thursday’s broadcast, that could cause all sorts of possible complications for the U.S., including a decreased value of the dollar and a higher price of U.S. goods on the international market.

But some envision a bleaker future, as demonstrated by this YouTube video.

Capitalizing on “red” China was a trend in the midterm elections. According to NPR, some 30 ads targeted China.

The ad depicts “one potential future scenario if America continues on its current destructive fiscal trajectory,” according to the Citizens Against Government Waste site.

If China were to dump all the dollars it holds and call in all its IOUs, one theory goes, the international market would be severely disrupted and deliver a devastating punch to the U.S. economy. Given that uncertainty, proponents believe China holds a trump card in the form of nearly $900 billion in U.S. debt.

But that scenario is highly unlikely, said Michael Boskin, professor of economics at Stanford University.

“China needs to grow. There are millions of people moving into the cities from the rural areas, and the Chinese government doesn’t want massive increases in unemployment,” Boskin said.

Therefore, it’s in China’s best interests for the U.S. to be economically stable and growing, and therefore buying Chinese exports. And with China (and other countries) financing U.S. debt, Americans see the benefit of cheaper consumer goods and financial instruments, like reduced interest rates on mortgages.

“It’s an uneasy situation and there’s room for frailty around the edges, but we both benefit,” Boskin added