China’s opportunity in U.S. debt trap

By Hari Sud
Column: Abroad View

Published: October 23, 2009

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Toronto, ON, Canada, — The U.S. public debt stands at US$11.9 trillion and rising, which has been the trend since 1980 when a major recession forced huge government borrowing and sales of U.S. Treasury bonds. U.S. President Ronald Reagan’s era was one of huge military spending. Money was borrowed and wasted on “pie in the sky” projects.

U.S. public debt is the government’s borrowings to fund the deficit. In 1980 it stood at about US$900 billion, which was manageable. It jumped to US$3.2 trillion by 1990. Reagan’s practice was to borrow and spend and see who came to collect.

A major push to control the deficit and debt began during former President Bill Clinton’s era. Although the debt increased, budget deficit trends were reversed. In 2000 public debt was still rising and stood at US$5.6 trillion.

It was during the administration of President George W. Bush that public debt ballooned to US$10.3 trillion. Bush offered too many tax cuts and initiated two wars, which were financed through borrowing.

Then came the financial turmoil of 2008, which almost led to the collapse of the U.S. banking system. A US$700 billion package was drawn to rescue it and a further US$800 billion stimulus package was offered by President Barack Obama to bail out Main Street. This was also financed with borrowed funds, ballooning the public debt to US$11.9 trillion in the last nine months.

But that is not the whole story. The U.S. private debt – individual, state, city and corporate borrowings – stands at around US$41-43 trillion. So the total debt load is about US$55 trillion, which defies description and raises questions as to how the United States has managed to stay afloat and be a world leader with this unmanageable debt. The answer is by borrowing more.

It was the surplus cash deposits of Japan, Taiwan, South Korea and the oil exporters of the Middle East that financed the U.S. public debt from 1980 to 2000. These nations liberally purchased U.S. Treasury bonds and left their money in U.S. banks, unworried because they believed the money was in safe hands.

The real concern began when China became the world’s biggest exporter and, like others, began to deposit its surplus export earnings in U.S. banks. With the cash they also bought U.S. Treasury bonds. At present China holds about US$900 billion in U.S. Treasury bonds.

So the U.S. has become China’s biggest debtor, which explains why U.S. foreign policy in Asia and the Pacific is hostage to Chinese pressures. It is no surprise that for the last 10 years the United States and China have been friends. The United States needs the money and China the exports. This interlocking of trade and financial interests has given China extra influence.

Imagine if in the next few years China tried to forcibly take over Taiwan. If the United States rushed to support Taiwan, China would likely threaten to dump its U.S. dollars in the open market, which could create chaos in global financial markets. This would threaten the U.S. economic structure, so it would back off and Taiwan would be permanently lost to China. This scenario is also possible in India or Russia.

China’s excessive influence on the world stage is unlikely to diminish any time soon, thanks to the United States’ building China with huge amounts of foreign direct investment, as well as importing everything from China.

Obama is tailoring his foreign policy to this situation. He has frozen U.S.-India relations, which were blooming under his predecessor’s presidency, and ducked meeting with the Dalai Lama recently just to placate China. Against Indian wishes, he is veering toward a pro-China policy where he is likely to abstain from voting at the Asian Development Bank meeting on a small amount of funds to build flood control measures in India’s Arunachal Pradesh state, which China claims it owns.

Internally, U.S. politics are slowly turning against Obama. The conservative Republican opposition has branded him a spendthrift due to the US$1.5 trillion added to the public debt by way of his two stimulus packages in the past ten months, although the bank bailout was done during the last days of Bush’s presidency.

Obama’s healthcare reforms are also not being openly accepted. Although the reforms are badly needed, overdue by 97 years, opposition Republicans say they will increase public debt. Although Obama is working hard to convince the opposition that the US$900 billion needed in the next 10 years for healthcare reforms will be recovered in the current healthcare mess or by way of taxes on the wealthy, the opposition voice is louder.

Obama’s other reforms on education, energy, and immigration are in jeopardy, as they all need money, which the United States does not have. Future borrowing from China and other rising economies like Brazil, India and Russia and other exporters is not sitting well with the U.S. public.

If the United States is not able get its financial house in order, its future role as leader of the free world is in jeopardy. No other nation has the muscle to step in except China.

Against this background Obama’s forthcoming visit to China is acquiring great importance. He is expected to discuss more borrowing, but also to deal with long-term problems of unbalanced trade, lowering the value of the yuan, taking manufacturing back to the United States, and elevating the yuan to a world currency at the expense of the dollar. Although there will be a big divide on most issues, the ambitions Chinese leadership will continue to pursue its aims.

It is interesting to note that U.S. economic hegemony lasted only 60 years – presupposing that China will dent U.S. economic might soon. Before the United States, the British ruled the waves for 200 years. In Asia, until the fall of dynastic rule in 1910, China was the Asian power. It was 50 years of turmoil that weakened China. The communist leaders were lost until they befriended the United States in 1971; now it appears they have gained the upper hand.

All this is happening because the United States allowed China to gain advantage after advantage. In the past 20 years, the Chinese have relocated almost all U.S. manufacturing to China. This has built up their exports and created a huge pile of cash reserves.

The world’s plea to the United States to stay within its means has fallen on deaf ears. Costly reforms like healthcare are being pursued without dealing with finances first. Budgets that have been out of control for the past 20 years are still out of control today. Stock markets are almost back to the level they were a year ago.

Borrowing and spending is slowly coming into vogue all over again. But nobody is talking about paying the massive debt. Liberals and conservatives are playing to the gallery and are busy voting for proposals that will add to the debt. The wars in Afghanistan and Iraq are not helping either.

All of this is good news to China, which will continue to make the United States more and more dependent on it.

(Hari Sud is a retired vice president of C-I-L Inc., a former investment strategies analyst and international relations manager. A graduate of Punjab University and the University of Missouri, he has lived in Canada for the past 34 years. ©Copyright Hari Sud.)