Question

Early in the 21^st century, China accumulated about $2 trillion in US government Debt. I remember during that time so called “experts” suggested that meant China had some ability to influence US policy since it owned so much debt it could inflict great damage to the US economy if they were to sell that debt onto the market suddenly and stop buying any more US debt. That never happened. Let’s speculate though and ask if China did sell all that US debt at one time could they have imposed economic damage on the US? If so, how? What would have been the impact on the Chinese economy from taking that action both in the short and long run?

You should consider a couple of things: 1) Why was China accumulating so much US debt at that time? (Hint: It has to do with exchange rates and the trade balance) 2) To China holding US debt was its Foreign Exchange Reserves, which are part of its Monetary Base.

A detailed response will be appreciated.

Answer 1

China is basically a manufacturing hub which is also an export driven economy. Since 1980s, big trade surplus with US. Early in the 21^st century, China accumulated about $2 trillion in US government Debt. If China sold all US debt,it impacts larger in short run and long run, it changes the economy, it floods the bond market, it impacts the US government ability to issue the debt. It affects the new debt issue at lower interest rates. It impacts the new borrowing , which force up the costs of raising funds. US is owed to China, buy the treasuries, big trade deficit with China, and China lends money to US, it helps to continue to buy all those imports. China invests in US treasury bonds and it helps to keep its export prices lower. Job generation is a motive of China to make their large population engaged productively. Impacts of China buying US debt includes piling up of the dollars and US debts, US can keep buying the chinese goods. It may lead to win-win situation for both the economies. It benefits both the the nations mutually, China becomes the huge market and US can buy the products for the ecnomic prices.