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HICKS: Debt a bigger problem than who bought it

March 26, 2011

It is difficult to ignore the many voices that fret over China as the banker to the United States in its time of worsening debt. It is an easy thing to look at an issue with emotion rather than facts, so this topic lends itself to some economic scrutiny.

Despite its high levels of growth, the People’s Republic of China is no place of economic miracles. It remains a dismal place, with average wages beneath what the United States enjoyed before Teddy Roosevelt was a soldier, much less president. China’s residents have the political freedoms of an African-American in South Carolina from about the same time period.

It will take something like a century to close the wage gap between the United States and China. That is why China—or rather the People’s Bank of China—has chosen to purchase so much debt from the United States. It needs to link itself to the security of our economy. But

The United States finances its lamentably large debt through the issuance of bonds (and similar financial instruments). This is a form of borrowing, but not one that is at all akin to bank borrowing. These bonds are sold in an open-auction market and come due at an established interval. Ten-year bonds are the most common and, unlike a small-business line of credit, cannot be called early.

The bond auction sets the interest rate American taxpayers must pay to borrow this money. The rates are low because our economy remains the most trustworthy in the world. Still, 18 cents on every dollar of taxes we pay goes to paying the interest on these bonds. As of the end of last year, China held $1.1 trillion in these securities, or about a quarter of the outstanding debt held by foreigners. These are big numbers, even to an economist who once worked for the U.S. Air Force. But what leverage does the People’s Bank of China have over the United States? The short answer is none.

A few pundits (possessed of more heated rhetoric than sizzling intellect) have claimed that China can simply call the debt. It cannot. The Chinese could sell the bonds, but the economists at the People’s Bank of China aren’t stupid. A big increase in the supply of bonds would reduce their price. If the People’s Bank of China wants to sell them off at a big loss, our Federal Reserve would be pleased to buy them back.

However, it is more likely that our exploding debt will require us to pay higher rates, just like any indebted credit card holder.

I am not a deficit hawk. In this column two years ago, I argued the debt was not yet a problem and that we had a year or two to set ourselves on a sustainable fiscal path. Quite the opposite has since happened.

The January 2011 deficit equaled the 2007 total annual deficit. In the end, it is the debt that threatens our national prosperity and security, not the folks who bought it.•

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Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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