Last Updated Jul 1, 2011 1:08 AM EDT
A couple of years ago the Treasury changed its rules for participating in bond auctions. According to an investigation by Reuters, this was done to stop China's use of third parties to get around limits on the quantity of Treasury bonds they could buy. In theory this would have given Beijing more leverage over the U.S. economy while keeping us in the dark about how much leverage the Chinese actually had.
Why the Chinese would need more leverage is the unanswered question. China holds at least $1.115 trillion in U.S. government debt, either directly or indirectly. According to U.S. government data released earlier this month, that accounts for roughly 26 percent of the paper issued by Washington.
Leverage, but little influence
This ostensibly gives Beijing a lot of power over America. It gives the Chinese the capability to trash the U.S. economy, because if the they sold their Treasuries all at once it would rapidly drive up interest rates. Not knowing the full extent of these holdings would make it even more difficult to assess China's political leverage over U.S. finances.
However, adding to these holdings is akin to adding to the U.S. nuclear arsenal -- even if you have the capability to blow up the world a dozen times, you can only actually do it once. The comparison to nuclear war is very apt (and not original with me). Just as the U.S. would do incalculable damage to itself by using its nukes, so would the Chinese by selling their bonds. It is not in the interest of the world's biggest lender and manufacturer to destroy the world's biggest borrower and buyer.
The two nations are bound to each other by this economic mutually assured destruction. As the old saying goes, "If you owe the bank $1,000, then the bank owns you. If you owe the bank $1 million, then you own the bank." Oh sure, the Chinese can be a bit more bossy towards us -- but that's about it. We can ignore their demands just as surely as they ignore ours on topics like human rights.
So far the Treasury's new rules appear to have made the borrowing more surreptitious instead of more in the open. In public, the Treasury claims it doesn't matter anyway because it has a diversified base of investors which means it isn't overly reliant on any one buyer of U.S. debt. As the Reuters article puts it: "Evidence that China was actually buying more than disclosed would cast doubt on those assurances."
Only if you believed them in the first place.