Washington’s Debt, Beijing’s Bubble, and the Discussion No One is Having

Mr. Ian Button

Washington, we have a problem. The economy is staggering its way out of the global financial crisis and none too quickly. Across the nation, unemployment rates in excess of 7 percent continue to pinch the pockets of middle-class Americans. The much-coveted AAA credit rating that once blessed Washington’s financial decisions has since become a pedestrian AA+.1 At $540.4 billion,2 the U.S. trade deficit in goods and services shows few signs of normalizing.

      Regrettably, Washington continues to spend at a breakneck pace despite the warning signs, relying heavily on cheap credit to fuel its consumption; between October 1 and December 7, 2012, the federal government borrowed 46 cents3 of every dollar it spent. Perhaps even more astounding is the exponential growth of the debt: some $47,0004 per second. At this rate, confiscating every cent of the world’s largest5 gross domestic product ($16.2 trillion) would still not be enough to repay the $16.8 trillion6 owed to creditors.
      Particularly disturbing is the nationality of these creditors—now more than ever they are foreigners. As of January 2013, foreign governments held some 34.3 percent7 of the U.S. national debt, a full 3.9 percent more than the holdings of U.S. individuals and institutions combined. Thus far, the nations holding this portion of the debt have had neither the capacity nor the desire to rock the dollar empire. But a few could, and of those few, China is far and away the largest and most troubling. Beijing has in its hands 8.1 percent of Washington’s debt, which, for those inclined to scoff, is not an insignificant amount.
      In theory, China can use its significant holdings of U.S. treasury bonds to tilt the playing field in its favor, forcing Washington to compromise anytime its interests conflict with those of Beijing. In practice, however, China cannot capitalize on this stick because it does not yet have a mature, battle-tested economy with alternative stock markets in which to invest its money. For better or worse, China is stuck with its U.S. treasury bonds.
      The Chinese know this, and they are not happy. Beijing fears that periodic depreciation of the U.S. dollar may turn its holdings into nothing more than valueless green paper. Moreover, China may never get the principal back thanks to America’s spending addiction. Should Washington’s credit rating continue its downward spiral, capital will be increasingly difficult—and expensive—to come by. More money will be spent paying down interest than actually paying back debt.
      This reality has not been lost on Beijing. Former Chinese Premier Wen Jiabao used to say that he could not sleep in peace every night because he worried incessantly about the money his government lent to the United States. Indeed, as the old adage attests, if a debtor owes $100, the debtor has a problem, but if the debtor owes $1 million, the creditor has a problem. In this analogy, China is the unhappy creditor. Fingers crossed, the Chinese can only hope that Uncle Sam comes to his senses.
      Hope, however, may not be enough to change Washington’s ways. Many American politicians seem to take comfort in the thought of Beijing opening its vast coffers anytime Washington comes running. At present, China has no choice but to acquiesce. But on a deeper level, can the United States count on China to be there? Can China sustain its credit kick?
      It may not. Emerging markets, no matter how meteoric their rise, have problems of their own, and China is no exception. After decades of defying free-market critics and American skeptics who believed China’s experiment with “red capitalism” was bound to fail, Beijing appears startlingly mortal thanks to its burgeoning debt problem. According to a July 29, 2013, article by the Associated Press,8 China announced an “urgent nationwide audit to find out how much debt the country really has.” This article’s release comes on the heels of another July 2013 article from Quartz9 entitled “China has at least 36 local governments with as much debt, on average, as Detroit.” Troubled by the prospect of bailing out the equivalent of 36 Detroits, Beijing wants to understand just how pervasive these municipal debt obligations really are.
      Moreover, China’s so-called “shadow banks” have been fanning debt-bubble fears thanks to their risky, under-regulated lending practices. According to a June 24, 2013, report by The Wall Street Journal:10
Economists inside and outside China worry that shadow lenders are introducing risks reminiscent of America’s subprime-mortgage boom by backing projects that may never pay off, failing to disclose fully what they are asking investors to fund and appearing to give banks a way to get rid of problem loans—without really doing so.
      Due to China’s heavy state regulation of traditional banks, many would-be Chinese borrowers cannot access proper financing, and those seeking high returns must accept middling deposit rates set by the government. Unless, of course, they turn to the much-maligned shadow banks for capital.
      Chinese citizens also face restrictions when growing their nest eggs. Unable to invest abroad, disappointed by meager returns at traditional banks, and weary of the wildly unpredictable stock market, many have turned to real estate as the savings vehicle of choice. As a result, China’s emerging middle class has poured generations’ worth of money into property, fueling a housing boom that is the country’s “main driver of growth,” according to CBS’ 60 Minutes.11 In this particular episode, the narrator explores the consequences of the building boom, not the least of which may be “the largest housing bubble in human history.” Throughout China there are “ghost cities” constructed to meet the investment needs of Chinese citizens, the vast majority of which are entirely uninhabited. According to estimates, “somewhere between 12 and 24 new cities” are constructed each year, displacing tens of millions of villagers along the way.
      Realizing the enormity of this bubble, Beijing instituted a “one apartment policy” in 2011. This policy was supposed to slow down the building boom and prevent the continued expansion of the real estate bubble. While demand cooled as anticipated, the Chinese government found itself grappling with numerous unintended consequences.12 Developers defaulted. Entire construction projects, indeed entire communities, halted mid-construction. Tianjin, a city that was supposed to one day supplant Manhattan as the world’s leading financial center, now “seems frozen.” Without the money needed to continue, many construction companies are now caught in a catch-22; they cannot afford to finish the project and cannot afford not to finish the project. If nothing is done, the bubble may well burst as a result.
      If this were to happen, the blast radius would not only include China’s 50 million construction workers, but also the burgeoning middle class and the peasants displaced by the building boom. To again quote 60 Minutes, Beijing’s “great fear is that this could lead to social unrest, and that’s not hypothetical.”13
      Put simply, China may not be the best choice for a bedrock on which to pile America’s debt. Already cracking under the weight of its municipal debt, shadow lending, and housing bubble, Beijing may actually buckle if Washington carries on with business as usual. Should the U.S. national debt continue to grow (as it is poised to do), leaders on both sides must ask themselves who, if not China, will carry Washington’s weight? And yet this is precisely the discussion no one is having.

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        11. See
        12. Ibid.
        13. Ibid.

The views expressed in this report are those of the author and do not necessarily reflect the official policy or position of the Department of the Army, the Department of Defense, or the U.S. Government. This opinion piece is cleared for public release; distribution is unlimited.

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