On China's Stake in U.S. Treasuries

The Congressional Research Service recently issued a report about "China's Currency: A Summary of the Economic Issues." It provides a succinct summary of the issues surrounding the U.S. trade imbalance with China and the way China values it's currency. The result is that China has become the largest foreign holder of U.S. securities. Here's a quote:

An undervalued yuan also has an effect on U.S. borrowers. When the U.S. runs a current account deficit with China, an equivalent amount of capital flows from China to the United States, as can be seen in the U.S. balance of payments accounts. This occurs because the Chinese central bank or private Chinese citizens are investing in U.S. assets, which allows more U.S. capital investment in plant and equipment to take place than would otherwise occur. Capital investment increases because the greater demand for U.S. assets puts downward pressure on U.S. interest rates, and firms are now willing to make investments that were previously unprofitable. This increases aggregate spending in the short run, all else equal, and also increases the size of the economy in the long run by increasing the capital stock.

Private firms are not the only beneficiaries of the lower interest rates caused by the capital inflow (trade deficit) from China. Interest-sensitive household spending, on goods such as consumer durables and housing, is also higher than it would be if capital from China did not flow into the United States. In addition, a large proportion of the U.S. assets bought by the Chinese, particularly by the central bank, are U.S. Treasury securities, which fund U.S. federal budget deficits. According to the U.S. Treasury Department, China holds $682 billion in U.S. Treasury securities as of October 2008, making China the largest foreign holder of such securities. If the U.S. trade deficit with China were eliminated, Chinese capital would no longer flow into this country on net, and the government would have to find other buyers of U.S. Treasuries. This could increase the government’s interest payments.