What will happen if China stops loaning money to the U.S.?
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) ?
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.
I'm sorry, but I can't find that number on the page you linked to. None of the tables i found there seem to contain data broken down by lending country. Can you please point me to the right document?
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?
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 - 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.
@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 https://www.treasury.gov/resource-center/data-chart-center/tic/Pages/fpis.aspx 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).
@Philipp - I had voted for closure. My own opinion that this question was so broad that it invited speculative answers, rather than factual ones. Empirically, we can see that many of the answers below don't cite their central claim to an outside source, which supports (but doesn't prove) the conclusion that this question is in fact, too broad.
@dave_thompson_085 Thank you for digging that up. I think we can now say with reasonable certainty that the 6.1 trillion figure in the question is wrong. I will edit it.
1.1 is not "staggering" compared to the 20 trillion of total debt. In fact, one could characterize it as a "drop in the bucket".
A bucket that only holds 20 drops isn’t much of a bucket. Why not avoid hyperbole in either direction, and call five percent: “five percent”?
The debt is in the currency US dollars which the US decides about. If the debt was in something more out of US control than the US dollar that may have been a totally different thing altogether.
I'm not allowed to answer because the question is protected. But my take would be that the debt gives China an incentive to keep US on it's feet to be able to repay. If you are indebted to me, then I am interested in you staying on your feet to be able to pay me back. Even more so as if the value of the US dollar was to plummet then China would be less wealthy as those debts would drop in value (as the debts are in US dollars). So by debt US has given China an incentive to help US stay up so to speak.
How much of this debt is to the Chinese government, and how much is to ordinary Chinese investors (non-government owned companies or individuals)?
@TylerDurden Why do you compare the USA debt to China with the total USA debt, instead of comparing it with the USA debt to other single countries? I'm not saying it's staggering or it's not, I have no idea and my point is only about logic. I'm saying that it would have been more meaningful to say like "China holds x% of USA total debt; the country that holds the greatest amount of USA total debt after China holds y%". In that case it would have been easier for people to tell whether it's staggering or not. F.ex. if x=5 and y=0.1, that's staggering, while if x=5 and y=4 that's not staggering.
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.
Yeah Japan is a HUGE creditor. Why don't people ever mention them? Glad you did, +1
It's important to point out that inflation means printing money out of thin air which reduces the value of the GDP growth over time. Inflation generally leads to more inflation in the long run because GDP never grows enough to subdue a constantly increasing debt in the long run.
Don't forget that said slowed GDP value growth is counterbalanced by the nominal growth caused by public spending. In business/investment terms: the USA of today is borrowing some money from the USA of tomorrow. As long as GDP is actually growing, the USA of tomorrow should have more money at its disposal as the USA of today. The USA of today certainly can put this money to good use and hopefully turn a "profit" in this. Furthermore, given inflation and disregarding interest, the USA of today will be able to buy more with the same amount of money than the USA of tomorrow would be.
I'm not qualified to make a proclamation such as "debt good" or "debt bad" or "debt okay-ish", same goes for inflation, suffice it to say though that simplistic analyses of these questions are likely to be fallacious. For instance, if the interest on national debt is lower than the inflation rate, borrowing is free money at your creditors' expense - in today's dollars, the numbers work out to you paying the debt off for less than you borrowed. (There might be other reasons why that's a bad idea.)
Also, debt-to-GDP seems to have been flat in the UK, Germany, and France (chosen as representative strong European economies) up until the credit crisis since 1995 - as far back as I can find data easily. Presumably these countries were borrowing money and had inflation during this period, which would imply their GDP growth was in fact matching pace with a constantly increasing debt.
A quick question - is it the governments that hold the debt or is the people who do it? The latter are probably less likely to stop loaning just because as the decision process is much more distributed (and I assumed this is the case).
@millimoose See crowding out) effect - government bonds compete with all other bonds and loans so the increase in goverment borrowing may out-compete private sector and make cost of borrowing money highier under some circumstances/long term.
"A country does not have a finite lifespan" - well, it does, it's just that we all *agree to pretend* it doesn't...
@MsJackson because unlike in the 80s hysterical economic nationalists in the US aren't worried about Japan eating Americas lunch.
I like how you attribute your statement that due to inflation the value of a loan decreases over time to an article in the economist that states that doing that on purpose is *a horrible horrible idea*. Its last sentence is literally "When inflation has been used to reduce debt in the past, it has usually happened because a government has resorted to this out of desperation and weakness, rather than because it has judged that it is in the best interest of the economy in the long-term." Some other quotes from the article:(...)
"On the primary deficit front, while higher inflation would boost tax revenues, it would also push up spending on state benefits and public sector wages. It is not clear that it would be beneficial; the UK recently blamed inflation for increasing its deficit." "On interest rates, investors would demand a higher interest rates to compensate for the inflation risk. While they might be surprised by inflation for a while, as they were in the 1970s, sending real rates negative (or even more negative than they are at present), they would eventually cotton on. Real rates in the 1980s were very high."
@sgf Well the whole idea of inflation is that it increases everything; it's not surprising that it increases deficits as well.
@sgf nobody said it should be done on purpose to pay off a debt. (Some) inflation is something that most central banks try to achieve anyway. And yes, that's already priced in the debt terms.
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?
The lifespan of the average country is probably about the same as the lifespan of the average person.
@hobbs : Possibly - but the distribution is rather different. There is no reason to believe that either US or China will cease to exist in the next 100 years or so. (It is *possible* that, eg, California will become independent, but if it does so, it will probably take a proportion of the US debt with it.)
@paul23: When the soviet union ceased to exist, Russia took its financial obligations (and weapons)
@kjetilbhalvorsen what about the roman empire. Or the greece city state of sparta? Or the egyptian dynasty or babylonian empire? Really keeping history to "lats 100 years" which american influenced people seem to do is arrogant.
@AndréParamés But then exactly the same terms apply to a private loan - And, since inflation is already computed in the terms, you don't gain anything by keeping your loans up. Yes, 1.2 Trillion will be worth less in 50 years, but you will be paying more than 1.2 Trillion in 50 years or noone will buy your bonds (except if your Germany).
@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".
To all those saying a country does have a finite lifespan, I would compare a country to a person who can never die of old age but can die of a disease. They *can* live forever, they just won't, and we have no way of knowing when they will die
@kjetilbhalvorsen, reminds me of the excellent science fiction novel *Battlefield Earth.* After winning the military battle to retake Earth, Mankind inherits the debt for the intergalactic mortgage used originally to pay for its invasion. :) *"'The simple fact of military take-over does not change the basic debt structure of a planet. That a government changes does not relieve the property of debt. Why, if that were true, then governments would just arrange to change hands every day and they would be rid of all their financial obligations.' He laughed. 'No, no...The new owners have to pay.'"*
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 Russian 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).
_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?
downvoted, China can just cut taxes and does not *need* to invest the money somwehere.
@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 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 - 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 you do not understand economics. Governments do not need to save money. China is buying US bonds to weaken their currency, not to save.
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.
Well you are not getting it , the annual deficit is in the range of 600-700 billion USD annually , Most of the countries don't even have the capacity to buy as much debt as that of China , because most of the nations don't have such a humongous trade surplus in USD as that of China. In case of US-China trade , China alone gets a trade surplus of over a 500 billion dollars. Give me an example of any nation which has such a humongous trade surplus.
@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.
Can this answer be backed up? It sounds reasonable in many ways, but how do you know with a reasonable degree of certainty that this is what the United States would do?
@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.
@Philipp Debt held by China is 1168 billion http://ticdata.treasury.gov/Publish/mfh.txt , which is only 7.6% of the federal debt held by public and only 5.6% of the total federal debt. https://treasurydirect.gov/NP/debt/current
_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 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.
They **are** already not borrowing from China and borrowing from someone else? (No). Why does it matter if it is 10% instead of 20? Shouldn't it be 0% if there were actually no reason to borrow from China instead of "someone else"? Why would a country borrow from its strongest adversary if said country has equivalent or better options? Can USA not stop Iran or North Korea from buying US bonds?
@SantiBailors Comments are not the best medium to explain this. I would recommend that you post a new question where you ask about the political implications of one state owning bonds of a different state.
@DavidRicherby A statement from a knowledgable expert or sufficient personal experience is generally how answers are backed up. You could claim your own personal experience in observing what happens when a store close. You could also get a statement from the store's management or staff about what is likely to happen, or some kind of marketing research about what customers of that store report they are likely to do. This is all important because in many cases customers won't be able to simply shop at another store (for example, because there are no substitutes available).
@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.
@SantiBailors as the old adage say, "If you owe the bank $100, that's your problem. If you owe the bank $100 million, that's the bank's problem.” - and if the US government owes you $1T, it's definitively your problem. If push comes to shove, what exactly will China do if the US refuses to pay?
@AndréParamés it goes even further than that. Since the debt is in US dollars, China has an incentive to keep US economy strong or else the value of the US dollar may go down which would make the debts less valuable. So USA has given China an incentive to help keep it strong.
@mathreadler _So USA has given China an incentive to help keep it strong._ That's great, it means that viewing China as an adversary that might weaken USA economy makes no sense after all, nor does any possible action taken by USA to counter China. It's a nice outcome.
@AndréParamés What you are saying is that USA has the upper hand because it took money from China with the promise of giving it back but actually it's not forced to give it back because it could break the promise without consequences, and that China was a fool in trusting USA's promise. While sadly you might be right, making this sound cool is a bit over the line. On a different note, if I owe the bank $100 million, _both_ I _and_ the bank have a problem.
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.
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.
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.
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.
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.
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.
3 trillion was printed from 2008-2014 https://fred.stlouisfed.org/series/BASE , but there was no price hyperinflation.
@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 - 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 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.
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.
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).
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.