Matt Yglesias, Slate’s business and economics correspondent, is a lot like Dr. Evil in that he often laments that he’s surrounded by frickin’ idiots. This confidence came through in force in Yglesias’ recent post titled, “Stop Being Wrong About China Buying Our Bonds.” Ironically, not only is Yglesias himself wrong, but his analysis is downright impressive in the depths of its error. Contrary to Yglesias’ claim, the Chinese government’s enormous stockpile of Treasuries does indeed give it leverage over the U.S. government.
Yglesias’ post opens up with characteristic bravado when he writes:
No subject attracts as much wrong commentary from people in positions of authority and influence as China’s purchases of American government debt. Recent antics around the debt ceiling managed to bring about a new surge in wrongness on this subject, so let me set you straight about it once and for all.
Before diving into Yglesias’ case, let’s review the basic facts. The following table is taken from an August 2013 Congressional Research Service report on Chinese holdings (which in context seems to mean Chinese government and central bank holdings) of U.S. debt:
As the table indicates, currently the Chinese constitute some 23 percent of the entire foreign holdings of U.S. Treasuries. Furthermore, the CRS report also indicates that between 2003 and 2012, the Chinese covered at least $40 billion of the U.S. budget deficit in a given year, with the exception of 2011 when China’s holdings of Treasuries slightly declined.
In this light, it’s understandable why so many analysts are alarmed. If for some reason the Chinese government should decide to halt its purchases — let alone dump its accumulated holdings — of Treasuries, surely this would have serious ramifications?
Yglesias argues that these fears are baseless; the situation depicted in the table above “doesn’t give China any leverage over the American government.” How does Yglesias reach such a counterintuitive conclusion? He first explains that at current exchange rates, Americans buy more goods from Chinese exporters than vice versa. This trade deficit by itself would mean more dollars chasing Chinese yuan in the foreign exchange markets. We’ll turn over the narrative to Yglesias’ own words:
Now in the natural course of floating exchange rates what would happen here is that the dollar price of Chinese money would rise, and this would increase the price of Chinese-made stuff in America and decrease the price of American-made stuff in China. That in turn would tend to discourage the flow of Chinese-made stuff to the United States of America.
But the Chinese government for various reasons wants to subsidize Chinese manufacturing. So they want to send those dollars they accumulate back to the United States….[W]hat they choose to do…is to purchase lots of US government debt. That’s a nice quiet way of limiting the extent of Chinese currency appreciation.
But that’s all it is. It’s not an investment…[I]t’s certainly not a favor to the United States of America. The American government doesn’t need China to provide it with American fiat money — we have plenty of American fiat money. [Bold added]
It’s hard to know where to begin in unpacking the problems with Yglesias’ glib position. One way to tackle it is to look at what is actually happening when the Chinese government chooses to buy Treasuries. Contrary to Yglesias’ description, it’s not really the case that American importers send U.S. dollars to Chinese exporters, who build up piles of American fiat money, and then have to find something to do with it. Rather, the more general case is that American importers (or the financial institutions acting on their behalf) go to the foreign exchange markets and buy Chinese money with their dollars first, then use the Chinese money to buy Chinese goods.
At the same time, if the Chinese central bank wants to acquire more U.S. Treasuries, it doesn’t walk around with hat in hand to various Chinese exporters, asking them to deposit the U.S. dollar bills they’ve accumulated. No, the Chinese central bank enters the foreign exchange markets, looking to buy U.S. dollars with Chinese money, in order to then buy U.S. Treasuries with American money. Thus, to claim that the Chinese government is effectively mailing back dollar bills — which is no favor to us since the Treasury can just print up more dollar bills on our end — isn’t even technically what’s going on.