The U.S. budget deficit is financed by borrowing. More and more of that money comes from China, now the United States' second-largest lender, after Japan. China's investment in U.S. government debt has more than tripled in the past five years, from $71 billion in 2000 to $242 billion in 2005.
Is that a problem? No, says the director of the Congressional Budget Office, Douglas Holtz-Eakin. "Dollars all look the same," he added. "Their ultimate source doesn't matter."
Under pressure to pay for hurricane recovery, the war in Iraq, a costly transportation bill, tax cuts, and a new prescription drug program, Congress and the president have been unwilling to raise taxes or make deep spending cuts. The only alternative is to borrow.
And foreigners are awash in U.S. dollars. Americans buy goods from abroad. Foreigners use the cash to buy U.S. debt. That keeps U.S. interest rates low, which makes the foreigners happy because it means Americans can continue to buy their goods.
In the view of Albert Keidel of the Carnegie Endowment, "It's not a problem." The Chinese, he added, "are becoming increasingly reasonable members of the world financial community. They don't want to be seen as irresponsible or vindictive."
According to Dominic Wilson, global economic analyst for Goldman Sachs, the Chinese "have no great interest in destabilizing either the U.S. bond market or the U.S. economy. This is a major export market. For China, it is the largest."
But isn't there something worrisome about Communist China financing the U.S. government? Wilson acknowledged some concern. "It is a situation that makes the U.S. more vulnerable to decisions of overseas governments and the decisions of overseas investors," he said. "That is not a situation that, over the long run, you want to be in."
Japan is still, by far, the largest U.S. lender, with $683 billion in U.S. debt, nearly three times as much as China. But the source of Japanese lending has shifted. About 18 months ago, the Japanese government began to move away from the large-scale purchase of U.S. securities, and its private sector stepped in to fill the gap. In China, however, it's the government that's lending money to the United States. Is that better or worse for the United States?
A government is more likely to be a stable investor. Private investors could be inclined to stampede or panic. But the Chinese government's investment in this country does give that government a lot of potential bargaining power. As Wilson of Goldman Sachs put it, "If you are thinking about the leverage that it gives to the Chinese government, that is obviously an easier bargaining chip to play when those securities are in the hands of government rather than the private sector."