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US's external debt to china is a staggering 1.1 trillion US dollars and according to many economists, it's highly unlikely that U.S. will be able to pay back the entire external debt to China in the next 4-5 decades or so.

So what will happen if China stops lending money to U.S. as prospects of ever getting back the debt is highly unlikely because of the ever increasing deficit and spending?

And is there any other nation other than China which can lend money to U.S. (Seems highly unlikely) ?

  • 3
    Where do you have the 6.1 trillion dollar figure from? Your source doesn't have it, and the source I found says the US only owes 1.2 trillion to the China government, which is just 10% of its total debt. – Philipp Mar 15 '18 at 14:17
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    By the way, Wikipedia says the whole foreign exchange reserves by the PRC are just 3.12 trillion USD. And those are loans given to all foreign governments, not just the United States. Wherever I look I can't find anything which corroborates your 6.1 trillion figure. Are you sure you didn't misunderstand something? – Philipp Mar 15 '18 at 14:33
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    4 people voted to close this question as "too broad". I don't understand why, considering that all the 3 answers essentially say "nothing serious will happen" and nobody posted a comment yet which explains why the question is too broad. – Philipp Mar 15 '18 at 15:50
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    @Philipp - I was torn between too broad and off-topic. This requires an in depth financial analysis to address properly (too low level for Quant SE and too high level for personal finance.SE). my answer was basically bumper sticker level; mostly to address question's assumptions. – user4012 Mar 15 '18 at 15:56
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    @Philipp+ in addition to the more focussed source used by Wikipedia (in Gramatik's answer), TIC does have this breakdown, with a lag and estimated, under treasury.gov/resource-center/data-chart-center/tic/Pages/… part A. It shows China holding $1.1T Treasury securities as of last June, and another $.2T of 'agency ABS' (almost certainly 'Fannie Mae' and 'Freddie Mac', which are almost-but-not-really government debt). – dave_thompson_085 Mar 16 '18 at 1:56

10 Answers 10

80

There are some assumptions being made by this question that don't reflect how the international economic order works.

Countries do not ever have to pay off all of their debt

A nation's finances are not like a person's. A person has a finite lifespan, and creditors take this into account when giving a loan. A country does not have a finite lifespan, and thus it has, in theory, forever to pay off its debt. Additionally, due to inflation, the value of a loan decreases over time. $1.2 Trillion will be worth less 50 years from now than it is today, which is another reason countries do not strive to pay off all their debt. If the money they are being credited drives growth such that the GDP growth minus the loan plus time is greater than GDP growth without the deficit-spending-aided growth, then the deficit was worth it.

Think of it like this, if you have a loan with an interest rate of 3%, but you have stock market investments that continually return at 7%, it is more profitable to maintain some level of investment rather than pay down all your debt in a sprint. Riskier, yes, but more profitable.

China is not the only creditor of the United States, large or otherwise

Japan is nearly as a large a creditor to the United States as China, each owning about 1/6th of the US debt that is held by foreign countries. Ireland, Brazil, and the UK are also large holders of US debt.

To answer your question directly

Yes. There are many other countries which can lend the US money, and as long as US debt is considered investment grade, countries will continue to buy it.

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    Yeah Japan is a HUGE creditor. Why don't people ever mention them? Glad you did, +1 – Ms Jackson Mar 15 '18 at 17:08
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    "A country does not have a finite lifespan" - well, it does, it's just that we all agree to pretend it doesn't... – AakashM Mar 16 '18 at 9:24
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    This is quite the arrogant notion: "A country does not have a finite lifespan". - Some humility and history lessons will learn you that no empire will ever last forever. -- Economics need to take the average lifespan of a country into account. Worse: depending on this is basically stealing from the future, akin to "the future will solve it". Shouldn't that be also taken into account in the answer? – paul23 Mar 18 '18 at 3:45
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    The lifespan of the average country is probably about the same as the lifespan of the average person. – hobbs Mar 18 '18 at 5:08
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    @paul23 It's just a bit tricky wording. Rather than "infinite lifespan", it's more like "unknown time to live". Averages don't help, since the differences between different countries and the government's sense of past obligations are just too varied (though reflected in e.g. the interest rates). As for your examples, those obligations weren't to the "country/nation" (there wasn't really such a thing), but mostly to the particular dynasty. And anyway, what's far more common than "dynasty/country dies out" is "dynasty/country renounces their obligations or banishes/kills the creditors". – Luaan Mar 19 '18 at 11:28
35

To add to Gramatiks' excellent answer, the question makes another incorrect assumption, that China is somehow doing US a favor by lending money.

On one hand, US clearly benefits by having more demand for its debt (and thus, duh, having the debt being cheaper - finance/economics 101). On the other hand, China is not doing this out of being nice, but of economic necessity. Warts and all, US Treasury debt is still among the very safest, least risky investments there are; and the only one at the scale that China as large investor can invest in (what are they going to do, sell US Treasuries and buy Iran Bank notes? Or Rusian debt? It may make some political statement, but very little financial sense). The fact is, they need to invest the money somewhere, to outpace inflation.

I'm going to omit the more wonky finance arguments pertaining to trade and currency exchanges, but that's also a factor (basically, if you trade in USD, you benefit from investing in USD based of course on exchange rate projections).

  • 2
    the question makes another incorrect assumption, that China is somehow doing US a favor by lending money Why? Where does the question seem to assume something like that, or that China is doing this out of being nice? I cannot see anything not even remotely like that in the question. Maybe it was edited out? – SantiBailors Mar 16 '18 at 14:11
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    @NoSenseEtAl - with all due respect you don't seem to understand finance. Unless China lives in a magical fairy world of 0% inflation, they don't have a choice of whether to invest money or not. The only choice is where. – user4012 Mar 16 '18 at 16:39
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    @user4012 Hmm. I'm not sure that the argument about inflation is really correct. The US has a large trade deficit with China. Buying US debt with those extra dollars helps keep the Remnibi from appreciating against the dollar. Read here – JimmyJames Mar 16 '18 at 20:19
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    @JimmyJames - the latter is a reason to invest in US debt. The former is a reason to invest ANYWHERE they can (which, thanks to the latter, as well as USTs being good investment, is best in US) – user4012 Mar 16 '18 at 20:48
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    @user4012 you do not understand economics. Governments do not need to save money. China is buying US bonds to weaken their currency, not to save. – NoSenseEtAl Mar 17 '18 at 6:23
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The United States would do what any other nation would do: Borrow the money from someone else. Either from other governments, from private banks or from private people. Governments do this by issuing government bonds. These are openly traded financial instruments. The government motivates people to buy these from them by guaranteeing an interest rate. When China stops buying US bonds, then the United States might have to pay a slightly higher interest rate to find more lenders.

By the way, according to this source, the Chinese government only holds 10% of the total debt of the United States government. Also, the amount held by China is currently going down, not up. So China actually does stop lending money to the United States, and it did not really seem to hurt the popularity of US government bonds much.

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    @AashishLoknathPanigrahi almost all countries are in debt. Their lenders are not just other governments but mostly private banks and private people. Government bonds of economically stable countries like the United States are rather popular financial investment to safely "park" unused capital because they are relatively safe and provide a guaranteed interest rate. – Philipp Mar 15 '18 at 14:12
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    @indigochild What kind of source are you looking for? Suppose I claim that, if a grocery store closes down, its customers will go shop somewhere else, rather than growing food in their gardens or whatever. Is there any source in the world that would back up that claim? I doubt it. – David Richerby Mar 16 '18 at 12:59
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    The United States would do what any other nation would do: Borrow the money from someone else Then why USA is not doing that already, instead of borrowing from the country that is perceived as its main rival / competitor or even - in some circles - trading adversary ? – SantiBailors Mar 16 '18 at 14:31
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    @SantiBailors They are already doing that. As I wrote in the second paragraph, only 10% of the US debt is to China. The comment by DavePhD says that the number might be even smaller. Also, keep in mind that bonds are openly traded financial instruments. The US could not stop another country from buying them up even if they tried. Finally, China owning US bonds is an issue which is far less serious than some people seem to assume, but that's material for a completely different question. – Philipp Mar 16 '18 at 14:33
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    @SantiBailors What do they stand to lose? If China collects a huge amount of US debt, the result is China's prosperity being linked directly to that of the US. – sgf Mar 16 '18 at 23:27
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There is detailed analysis of this issue in U.S. Financial Exposure to China, U.S.-China Economic and Security Review Commission, 9 May 2017.

As best seen in Fig. 4 of the report, mainland China decreased its holdings of US treasuries from 1.25 trillion to 1.05 trillion in only a 5 month period (6/2016 to 11/2016). This correlated with roughly an 80 basis point spike in 5 and 10 year rates (See Fig. 5).

The report cites the approximation:

a $100 billion decrease in foreign official purchases of U.S. Treasuries in a given month increases the five-year Treasury yield by 40–60 basis points (bps) in the short run and by 20 bps in the long run.

So with mainland China currently holding $1.17 trillion, if China stopped lending completely, and no other foreign country increased its lending, there could be a short term 6% (600 bps) increase and a long term 2.3% (230 bps) increase. A 230 bps increase from current levels would still be lower than most of the 1965 to 2005 time period.

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    I think this is the best answer as to what we would expect occur. Demand for US debt would drop and therefore the rates would increase. – JimmyJames Mar 16 '18 at 20:24
  • I agree. Quantifying the impact is what really matters once you have the facts. The only flaw is that this analysis is done in isolation, but an event that would lead to Chinese divestment of U.S. Treasuries would only happen in a geopolitical environment in which the events causing the divestment would have confounding effects including a probable stock market crash, increased militarization, etc. which might lead to a flight to safety that could mitigate this effect on interest rates, or exacerbate the effect. – ohwilleke Mar 20 '18 at 18:16
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You can look at it this way. The United States borrows money by selling bonds. Anyone can buy those bonds, and they're considered to be safe investments because the United States has not yet defaulted on paying back those bonds. As a result, the interest rate on those bonds is quite low.

China happens to wisely invest its money by buying lots and lots of US government bonds along with everyone else. China owns a large amount of those bonds, but many of those bonds are owned by other countries, individuals, and financial institutions. It's not like the US went directly to China and signed up for a loan, so it's a more general bond-issuer, bond-holder relationship and not a bank loan type of relationship.

The United States can't just choose to not pay back just China and it can't choose to loan money just from China. The debt goes to whoever buys the bonds, and the US government either pays up when bond holders redeem their bonds or it doesn't.

So if China decided decided not to loan any more money, it would just stop buying US government bonds. Presumably, other investors would fill in the gap by buying more bonds. If the bonds could not be sold, the US government would either have to issue bonds with a higher interest rate, attracting more investors, or reduce its spending.

If the US government became so dysfunctional that decided it can't pay back its debts, all bond holders would suffer, not just China. In that scenario, the interest rates on future US bonds would increase drastically, otherwise no buyers could be found. The value of current bonds would drop drastically, since there would be much less confidence that those bonds could ever be redeemed.

Remember, it's not a bank loan type of relationship the US government has with China, it's a bond investor type of relationship, and there are a lot more investors than just China.

11

Worst case, the US federal reserve prints another trillion dollars to pay back the debt, deliberately triggering hyperinflation which makes the debt worth next to nothing (Russia and Germany both did this in the early 20th Century). Unfortunately this also tends to screw the economically disadvantaged and the middle class which leads to social unrest, which in the case of Russia and Germany led to the fall of Tzarist Russia to the Bolsheviks and the rise of fall of the German Weimar Republic to Fascism.

On the other hand, I'm reminded of the old maxim that if you owe the bank a thousand dollars that's your problem, but if you owe the bank a million dollars then that's the banks problem. This level of international financial interdependency is one of the reasons we haven't had a war between the major powers in almost a century.

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    3 trillion was printed from 2008-2014 fred.stlouisfed.org/series/BASE , but there was no price hyperinflation. – DavePhD Mar 16 '18 at 13:01
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    @DavePhD Not disagreeing, definitely not hyperinflation, but a couple thoughts. The Consumer Price Index has gone up 20% since 2008, which is significant (though not significantly more than the trend since leaving the gold standard in the 70s, sadly). Also noticed your source chart is "currency in circulation"; wondering how much of that was re-circulated cash from more favorable investing options, and if currency taken out of circulation is accounted for in the numbers. – brichins Mar 16 '18 at 22:06
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    @brichins - If the price level goes up 20% in 10 years (2008 to 2018), that's less than 2% per year on average over the 10-year period. By the way, the US did not "leave the gold standard" in the 1970s, mostly because it hadn't been on the gold standard since the 1930s. To liken the Bretton Woods system of currency pegs to a type of "gold standard" is grossly misleading. Moreover, average annual CPI inflation in the 1960s exceeded 2%. For sure, the Bretton Woods system did not, by itself, guarantee price stability. – Mico Mar 17 '18 at 11:39
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    @Mico I was not familiar with Bretton Woods system - thanks for the reading suggestion. :) Was mostly just saying that increasing the amount of currency in circulation wasn't without effect at all; seems like there is little attention given to inflation by the media or people I interact with. Beginner at large-scale financial matters here, need to do a lot more studying. – brichins Mar 19 '18 at 15:45
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As long as China runs a trade surplus with the US, it's building up dollar reserves. There's not much it can do with those dollar reserves other than lending them to the US, or spending them with someone else in a third country who will then lend them to the US. If the US's trade deficit shrinks then its need for government borrowing will also shrink.

7

Trading Economics has a good historic graph of US debt. The US does not owe $6 trillion to China. Some of the US debt is owed to Americans - think of the new government money market funds, which own treasuries and are with some brokerages the "default" fund (replacing the old money market funds). The discussions about the debt don't always mention that it's not ONLY foreigners who own US debt, but also some Americans.

Even with the debt and even if China, Japan and all other countries stopped buying treasuries, the US could buy its own debt similar to what the Fed did with the QEs - purchasing their own bonds. The US has assets, which rarely get discussed, such as student loans, the exchange stabilization fund, and 8100 tons of gold. Wrap that up with the second largest amount of natural resources and even with the dollar losing some value, it still won't go to zero like pundits claim.

6

So what will happen if China stops lending money to U.S. as prospects of ever getting back the debt is highly unlikely because of the ever increasing deficit and spending?

US National debt exists in the form of US Treasury bonds. If Chinese government buys less of them, then their price will fall until other buyers step in and start buying.

If there are no buyers in the market, the Federal Reserve steps in and buys the rest of the bonds offered for sale. Since the Federal Reserve has no limit on how many bonds it can buy, this process need not ever stop.

Although if it happens too fast, it would increase inflation (because it would increase the amount of money in circulation without increasing the amount of goods and services in the economy). This would render all the bonds that Chinese banks are holding worth less (if not worthless). But as long as the whole process is controlled and happens slowly, no one loses more than they can afford to lose (and everyone gains a stable economic system).

0

While 1.1T looks huge it is actually not that big when you consider the size of the US debt.

Only big problem that can happen is that it could trigger a panic in a similar fashion as bank runs happen.

So while the most probable case is that the interest rates US would need to pay are just gonna increase a bit it is possible that it could trigger a debt crisis.

  • 1
    Interesting point that it's about 5% of the overall debt. – KriyanshAurik May 24 '18 at 12:22

protected by Philipp Mar 17 '18 at 12:10

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