The explanation for China's frayed nerves is pretty simple: Beijing owns $1.28 trillion in U.S. Treasury bills, a figure higher than any other country in the world. The devaluation of the U.S. dollar would reduce the value of China's holdings and make it more difficult for Americans to purchase Chinese imports, which is a key component of the country's growth model.
Here's how this works. Ever since China began opening its economy up to markets in the late 1970s, its growth has been driven, in large part, by cheap labor and a cheap currency. In other words, China manufactured inexpensive goods and sold them to consumers in richer countries, like the U.S. But there's a problem. Normally this influx of U.S. dollars would make the Chinese renminbi rise against it—and China would cease to have such a cheap currency. That would be good news for Chinese consumers, but not for Chinese exports. So, instead, the government doesn't let the renminbi rise. It recycles its dollars into the safest dollar-denominated assets there are—U.S. Treasury bonds.
Put another way, China doesn't buy U.S. Treasury Bills because it wants to—it does because it has to. Patrick Chovanec, chief strategist at Silvercrest Asset Management and an expert on the Chinese economy, put it to me this way: “Imagine that the Chinese economy is a store where the U.S. economy buys products and pays for them with IOUs. The Chinese economy can either keep extending credits to the U.S. to pay for goods, or go out of business. That's the dilemma.”
This mutually-assured destruction isn't all bad; for one thing, it goes against the common assumption that the Sino-American relationship is necessarily zero-sum. But there are also signs that the current arrangement is not sustainable. According to Arthur Kroeber, the Managing Director of GaveKal Dragonomics, a Beijing-based economics research firm, Beijing's total possession of U.S. foreign reserves has remained static over the last two years, and China is now relying less on foreign trade than before. In addition, Chinese politicians may feel domestic pressure to move away from U.S. holdings in light of the embarrassing spectacle in Washington.
Yet there's little sign that the economic interdependence that underpins the Sino-American relationship is going anywhere. Following Zhu Guangyao's criticism of the “attitude of the Tea Party,” Congressman Blake Farenthold (R-Texas) retorted that the Chinese “need to stay out of our politics.” But given how much is at stake for China, though, you could argue that it's their politics, too.