One of the Most Popular Doom Scenarios for the U.S. Economy Is Fizzling Out

If you're worried about China, you should be worried about it for the right reasons

For years, politicians, gloomy newsletter writers, and even some economists have been warning that the U.S. is at the mercy of China, because China owns so much Treasury debt. 

In 2010, a group called Citizens Against Government Waste made an infamous commercial called the Chinese Professor, in which a professor in Beijing in the year 2030 teaches his class about the demise of the U.S. because its government spent so much money and mortgaged the country's future to the Chinese.

https://www.youtube.com/watch?v=OTSQozWP-rM

 This fear continues to this day. Conservative news sites play this up regularly (see here and here). And just this past week on the campaign trail, in the midst of the global market turmoil, Chris Christie warned that Obama's reckless borrowing made the U.S. vulnerable to Chinese economic fluctuations.

Anyway, there's just one problem with all this, which is that the story isn't playing out. 

As Bloomberg Intelligence economist Tom Orlik notes in a research piece today, China hasn't been adding to its U.S. Treasury holdings for a long time. (Chinese holdings of U.S. Treasuries are a little tough to calculate precisely, because China routes some of the purchases through financial centers such as Belgium and Switzerland—hence the dotted white line above, in addition to the green line, which is the direct holdings.)

Source: Tom Orlik, Bloomberg Intelligence

Orlik writes in his piece: 

The U.S. has long feared that China’s massive holdings of its debt could be deployed as a weapon of financial mass destruction. That’s what prompted former U.S. Treasury Secretary Larry Summers to talk of a 'balance of financial terror' between the two nations during a speech in early 2004.

Now, news reports point to China selling down its holdings of Treasuries to help smooth the yuan’s depreciation path. That’s an important development. But if China’s U.S. Treasury stock is a nuclear bomb, moderate sales to offset selling pressure on the yuan are unlikely to set off an explosion.

The bottom line is that we haven't seen upward pressure on U.S. rates (at all) during this selling. If anything, U.S. borrowing costs continue to confound economists, who always think higher rates are right around the corner.  

Here's a chart of the yield on 10-year and 30-year rates going back to the beginning of 2014. As you can see, the yields remain quite low in the face of this selling. 

Not only have rates gone nowhere during this time, but if we blow out the chart further, you can see we remain basically at historical lows.

Source: Bloomberg

There's just zero evidence that China reducing its holdings of U.S. debt is creating any real pressure on anything. In fact, even if China really wanted to dump U.S. debt for the sole purpose of causing economic harm, there just aren't any alternative assets that are as deep or as liquid.

A confluence of events seems guaranteed to thrust China's holdings of U.S. debt back into the spotlight.  China has been selling Treasuries lately to prevent the yuan from weakening beyond where it wants. And with the GOP primary frontrunner (Trump) making trade with China a big issue, there's bound to be a lot of discussion of the U.S./China relationship (basically Trump is deciding what GOP contenders talk about). Marco Rubio is set to deliver a big China speech on Friday. Scott Walker is also about to deliver a foreign policy speech. Chris Christie's statements were pointed out above.

But while it makes for good politics, it's not a real issue of concern. What matters in the real U.S. economy and to the Fed is of far more importance than China's mix of foreign reserves.  

Still, as the world gets more intertwined (both financially and economically), China's growth issues will become more of a global concern. That's the topic of Peter Coy's new Bloomberg BusinessWeek cover story. The linkages are real, but the debt-dumping doom scenario that's likely to come up on the campaign trail isn't likely to be the channel of contagion. 

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