Japan’s Assumption of America’s Debt Is a Good Thing for China

Statistics from the U.S. Treasury Department show that, in the past year, Japan has purchased a total of $53.3 billion in Treasury bonds, an increase of 7.2 percent. Currently, Japan holds a total of $821 billion in Treasury bonds. In contrast, China’s total holdings of United States debt reduced by 5.4 percent, or $48.1 billion, in the last year. Japan has thus surpassed China and become the largest holder of American debt for the first time since August 2008.

In the past 10 years, the American government has been constantly borrowing, and the total debt has increased by 100 percent to reach $12.9 trillion. According to White House estimates, the national debt will exceed $18 trillion by 2014. America’s debt is growing ever larger, and the only recourse is to print more money to pay for the debt. Therefore, the depreciation of the American dollar is unavoidable. Furthermore, data from the Bank of America shows that the average yield on U.S. Treasury bonds has slipped from 5.21 percent during the financial crisis in 2007 down to 1.31 percent today.

Since the financial crisis began, the security of Treasury debt has been questionable. Over 60 percent of China’s $2.45 trillion in foreign exchange reserves are American assets, including United States debt, other bonds, and securities totaling $1.5 trillion. A weak American dollar means these assets will gradually shrink. Paul Krugman, a famous American economist, indicated that the predicted investment losses on United States debt will ultimately reach 20 to 30 percent. China has become ensnared in the American dollar issue. Moreover, it can neither extricate itself nor change the policies that got it there in the first place.

Actually, China has been having a fierce debate about whether it should continue to purchase American debt for a long time now. Now, many economists and the general public do not support buying United States debt. They believe that not only is the market value of United States debt decreasing, but the value of the American dollar may decrease sharply after the financial market stabilizes. If China continues to buy United States debt, then it will sustain a huge loss, which is not in the national interest.

In that case, if inflation is on the rise and the interest rate on Treasury bonds is likely to tumble, why would Japan want to do something counter to its national interest? Some analysts believe two things. First, once Japan has bought more Treasury bonds than China, and the value of the bonds fall, other assets will shrink. Second, if the value of bonds falls, that means the U.S. dollar will become weaker, which also means that the yen will become stronger compared to the U.S. dollar. This would definitely have an adverse effect on export trade between Japan and America.

Even though the yield rates on U.S. Treasury bonds are the lowest they have ever been in 40 years, Japan still believes that America may experience its own “lost decade,” an economic slump that Japan experienced in the late 1980s. For this reason, Japan’s good favor on United States debt has surpassed China yet again. They can do it. They can give a little extra effort to prop up the U.S. dollar so it does not fall too violently. They do this because a sharp decrease in the dollar would severely affect Japanese exports, and would also make it more likely that the American dollar would be used instead of the yen for currency arbitrage.

After interests rates fell in the world’s major developed economies, Japan’s already low interest rate was no longer special, and Japan lost much of its ability to attract investors. As the difference in interest rates reduced, the profits on activities that depended on this interest rate also shrank. As the interest rate drops to nearly zero in America, no one knows whether investors will use the U.S. dollar as a low rate currency instead of the yen or use the American dollar with the euro, the Australian dollar and other currencies with high interest rates.

One has to admit that holding or reducing a large amount of United States debt will undoubtedly have political and strategic significance. The logic is simple: One grain of sand will not tip a scale, but a large bag of sand will definitely tip a scale. If a country holds a small amount of United States debt, the American government will not mind, but if a country becomes the biggest or second biggest holder of United States debt, America has no choice but to pay attention and to treat that country with caution.

For this reason, whether China moves to increase or decrease the U.S. Treasury bonds it buys, any action regarding the United States debt will have political and strategic implications. These implications are sometimes overstated, but they are not entirely groundless. An analysis in the Wall Street Journal put forth the opinion that China had reduced the amount of U.S. Treasury bonds it held in order to use the American assets it already had on hand, as well as exert pressure on America and counterattack America’s aggressive trade and exchange rate policies. Even though it may not be considered pressure, it would still give a sign to America. China can hold a silent protest against America’s trade policies and its giant deficit.

We are relieved to see that Japan has bought more U.S. Treasury bonds than China because that means that it can carry a large burden for China. This is a good thing for China. When it comes to buying U.S. Treasury bonds, China should let Japan do most of the work. When looked at another way, instead of spending a lot of money purchasing U.S. Treasury bonds, China can use that money to complete projects at home. In this way it can better benefit the people. China itself is a big market, and it should not forget this fact when trying to develop its economy. China is currently trying to stimulate domestic consumption, which has a lot of potential. If one believes that domestic demand has a strong potential and the growth of domestic investment is guaranteed by appropriate policies, then one does not need to worry about a large reduction in foreign demand.