Chinese Debt Nonsense

The other debt news of the day is another thundering warning from the Chinese media lecturing the United States about the need for our country to “cure its addiction to debts.”

As is the case every time this kind of thing happens, most media coverage isn’t highlighting the appropriate elements of context. But to review, many countries have historically used “capital controls” to regulate the inflow and outflow of foreign money. Such controls increase monetary policy autonomy and make it easier for the control-imposing country to stabilize its economy against the business cycle. But capital controls also impose various kinds of inefficiencies. Policymakers need to weigh these options. Currently, China has capital controls and the United States does not. Part of how this plays out is that US efforts to stimulate our economy through monetary expansion and currency depreciation are being undermined by Chinese purchases of dollar-denominated debt. In other words, the Chinese, for policy reasons all of their own, are purchasing American debt in order to achieve the goals of PRC exchange rate policy.

Which is fine. The US has decided that open capital markets are in our interest. The price we pay for that is reduced monetary policy autonomy. And China has decided that massive purchases of dollar-denominated debt are in their interest. The price they pay for that is to subsidize US consumption and de facto tax Chinese consumption.

This is what it is and precisely what it isn’t is some kind of favor the Chinese government is doing to the American government. The long-held position of the US government is that the Chinese government should stop doing this. That would push up the price of Chinese money relative to the price of dollars. And that, in turn, is something that we think would improve the US trade balance and create jobs in the United States. But the Chinese, for reasons relating to their own political and economic situation, don’t want to do that. So fair enough. That means, however, that if they turn around and whine about US policy in the Chinese media we need to understand that as either confusion or else something met for domestic consumption. It’s not a real threat. We’ve been asking them to stop buying so much American debt for years.