When you're seeking a loan, do you spend a lot of time worrying about the moral probity of the lender? Or do you take the money and run?
Right. You get the best deal you can and bolt before the lender changes his mind.
The U.S. government operates much the same way. When it needs to borrow (which is basically all the time), it issues debt on the public markets to any legitimate investor who's willing to buy it. There's no test for political leanings and no quota for how much any one investor can purchase. And once investors buy treasury securities, they're free to sell them to other investors on the open market or hold onto them until they mature.
Republican presidential nominee Mitt Romney, who made a fortune as a professional financier, apparently thinks this whole system is a bad idea. In his acceptance speech at the Republican National Convention, Romney singled out U.S. government debt held by China as an alarming sign of national decline. "Does the America we want borrow a trillion dollars from China?" Romney asked rhetorically, while ticking off ways he feels American prestige has suffered under President Obama.
Romney probably knows this, but there's nothing wrong with the U.S. government borrowing from China, or from any other foreigner with money. "It's a pretty good deal for the United States," says Donald Boudreaux, an economics professor at George Mason University and author of the bookHypocrites and Half-Wits, which calls out dozens of popular myths about how the economy works. "Borrowing from China keeps interest rates lower than they would otherwise be and lowers the tax burden on Americans."
China is an easy bogeyman for U.S. politicians, because it's an ocean away and it's still run by the Communist Party. But the economic threat posed by China is routinely exaggerated. Investors in China do hold about $1.2 trillion in U.S. government debt, but that's only about 7.3 percent of all U.S. debt, and 10.3 percent of debt held by the public. (Government agencies such as the Federal Reserve hold about $5 trillion of America's $16 trillion in total debt.) Japan holds nearly as much U.S. debt as China does, but nobody ever complains about Americans being in hock to the Japanese.
The size of America's national debt is itself a problem, because Washington depends on borrowed money for too much of its everyday expenditures. But that's the borrower's fault, not the lender's. "The whole thing is silly," says Boudreaux. "Blaming the Chinese lets the people creating the debt off the hook. And that's Congress."
Investors in China, which include arms of the government as well as private entities, buy U.S. debt for the same reason anybody else does: They need to invest their savings in something, and U.S. treasuries are attractive because they're safe and liquid. But buying U.S. debt gives the Chinese no control over the U.S. economy. In fact, strong demand for U.S. debt by Chinese holders pushes long-term interest rates in the United States lower, because more buyers means the price—the interest rate paid by the borrower—goes down. That, in turn, pushes down rates on mortgages and other types of consumer loans, which are closely linked to the rates paid on U.S. treasuries.
Strong demand from China and other overseas borrowers also benefits the U.S. government, since lower rates reduce its own funding costs. That allows the government to keep taxes lower than they would otherwise be. If borrowing costs went up, Washington couldn't afford to borrow as much, and would have to make up the difference through higher taxes or reduced spending.
Some people fear that China could torpedo the U.S. economy by suddenly dumping its treasury holdings. But that's not really plausible, either. China could do that, theoretically, but it might hurt China more than the United States. A surge in the supply of treasuries on the market would lower their value and force interest rates up, at least for a while. That could harm the U.S. economy. But with the value of treasuries falling, China would end up selling most of its holdings at a loss. Once other investors figured out what was going on, they'd probably sense a bargain and snap up those securities at fire-sale prices, which would bring rates back down. And since China controls only about one-tenth of all treasuries on the market. it's not as if sinister communists have exactly cornered the market.
Besides, China has, in fact, been selling off treasuries. Its holdings peaked last summer at a little more than $1.3 trillion and have since fallen by about 9 percent. That could be due to the routine ebb and flow in investor accounts, or it could be a deliberate effort by Chinese authorities to gradually reduce Chinese holdings of U.S. debt. Whatever the case, the modest drawdown hasn't caused any disruption to treasury markets or the U.S. economy.
America's real economic vulnerability has nothing to do with who holds its debt, but with its addiction to borrowed money in the first place. And if the borrowing continues at the pace of recent years, it could threaten America's ability to pay back what it owes. That would be a far bigger problem than any scheme the Chinese could concoct.
Two days before Mitt Romney spoke at the Republican convention, former Secretary of State Condoleezza Rice took to the podium and warned that "there is no country, not even a rising China, that can do more harm to us than we can do to ourselves." Mitt Romney might want to ask her for a briefing.
Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.