The US Debt to China

Exactly How Much U.S. Debt Does China Own? And Why?

u.s. debt to china illustration
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The U.S. debt to China is $1.18 trillion as of May 2018. That's 19 percent of the $6.2 trillion in Treasury bills, notes, and bonds held by foreign countries. The rest of the $21 trillion national debt is owned by either the American people or by the U.S. government itself. 

China holds more of the U.S. debt than the $1.05 trillion held by Japan. China increased its holdings from $1.05 trillion in January 2017. During that same period, Japan decreased its holdings from $1.10 trillion. 

In November 2013, China held $1.3 trillion in U.S. debt. China reduced its holdings between then and 2017 to allow its currency, the yuan, to rise. To do that, China had to loosen its peg to the dollar. That made the yuan more attractive to forex traders in global markets.

Long-term, China wants the yuan to replace the U.S. dollar as the world's global currency. China is also responding to accusations of manipulation. Most countries want their currency values to fall so they can win the global currency wars. Countries with lower currency values export more since their products cost less when sold in foreign countries.

Before February 2014, China had been strengthening the yuan to dollar conversion in response to U.S. pressure. But it reversed course when the dollar rose 25 percent in 2014 and 2015, creating an asset bubble. Since the yuan was pegged to the dollar, the increase dragged the yuan's value with it. China had to lower the yuan to remain competitive with other emerging markets that had free-floating currencies. In 2018, the dollar began weakening again. China can allow the yuan to rise without hurting its competitiveness with its neighbors.

China has consistently held more than $1 trillion in U.S. debt every year since 2010. That's when the Treasury Department changed how it measures the debt. Before July 2010, Treasury reports showed that China held $843 billion in debt. This makes it difficult to make long-term comparisons. 

How China Became One of America's Biggest Bankers

China is more than happy to own almost a fifth of the U.S. debt owned by foreigners. Owning U.S. Treasury notes helps China's economy grow by keeping its currency weaker than the dollar and Chinese exports cheaper than U.S. products. China's highest priority is creating enough jobs for its 1.4 billion people.

The United States allowed China to become one of its biggest bankers because the American people enjoy low consumer prices. Selling debt to China funds federal government programs that allow the U.S. economy to grow. It also keeps U.S. interest rates low. But China's ownership of the U.S. debt is shifting the economic balance of power in its favor.

Why China Owns So Much U.S. Debt

China makes sure the yuan is always low relative to the U.S. dollar. Why? Part of its economic strategy is to keep its export prices competitive. It does this by holding the yuan at a fixed rate compared to a "currency basket" of which the majority is the dollar. When the dollar falls in value, the Chinese government uses dollars it has on hand to buy Treasuries. It receives these dollars from Chinese companies that receive them as payments for their exports. China's Treasury purchases increase demand for the dollar and thus its value.

Also, China promises to redeem dollars for yuan at the fixed rate. It must keep a good supply of Treasury notes in reserve to do that.

China's position as America's largest banker gives it some political leverage. Now and then, China threatens to sell part of its debt holdings. It knows that if it does, U.S. interest rates would rise, slowing U.S economic growth. China often calls for a new global currency to replace the dollar, which is used in most international transactions. China does this whenever the United States allows the value of the dollar to drop. That makes the debt China holds less valuable.

What Happens If China Called in Its Debt Holdings

China would not call in its debt all at once. If it did, the demand for the dollar would plummet. This dollar collapse would disrupt international markets even more than the 2008 financial crisis. China's economy would suffer along with everyone else's.

It's more likely that China would slowly begin selling off its Treasury holdings. Even when it just warns that it plans to do so, dollar demand starts to drop. That hurts China's competitiveness. As it raises its export prices, U.S. consumers would buy American products instead. China could only start this process if it further expands its exports to other Asian countries and increases domestic demand. 

China's Debt-Holder Strategy Is Working

China's low-cost competitive strategy worked. Its economy grew 10 percent annually for the three decades before the recession. As of 2018, it's growing at nearly 7 percent, a more sustainable rate. China has become the largest economy in the world, outpacing the United States and the European Union. China also became the world's biggest exporter in 2010. China needs this growth to raise its low standard of living. Despite its threats, China will continue to be one of the world's largest holders of U.S. debt.