Should China and Japan have some special influence on U.S. fiscal policies? After all, they own more than $2.4 trillion of U.S. government bonds, and routinely use this as an excuse to tell us what to do. Officials are darkly warning about the need to reconsider their portfolio allocations. Some worry that a U.S. debt default -- even a temporary one -- might lead these countries to go on a buyer’s strike, or even sell their bonds outright.
While a default is undesirable, these concerns are probably misplaced. Paradoxically, it is likelier that a U.S. default would push the Chinese and Japanese to increase their purchases of dollar-denominated assets.
China and Japan (and other countries) have accumulated trillions of dollars’ worth of U.S. government debt because they want to control the value of their currencies in international markets, not because they are saving reserves for a rainy day or because they are trying to earn profits. Cheap currencies subsidize exports and make imports more expensive, all without falling afoul of World Trade Organization rules.
As the Carnegie Endowment’s Michael Pettis has eloquently explained, these policies boost employment in the countries that use them while producing yawning trade deficits in the U.S. A recent study by David Autor, David Dorn and Gordon Hansen found that these trade deficits depress employment and increase government spending on disability benefits. Rather than an unalloyed benefit, foreign purchases of U.S. government debt have therefore made many people here worse off, all for the benefit of workers in other countries. (The full distributional impact is a little more complicated: Some U.S. consumers benefit from cheaper imports while many people in China suffer because foreign goods are so expensive.)
The motivations for these purchases explain why Chinese threats about its “financial weapon” were always empty. In fact, the Pentagon recently concluded that “attempting to use U.S. Treasury securities as a coercive tool would have limited effect and likely would do more harm to China than to the United States.”
The same logic applies to a default on U.S. sovereign debt. Profit-seeking investors would rightly try to get their money out of a country with such dysfunctional political institutions by selling every dollar-denominated asset they own. The Federal Reserve could offset the impact of these sales on domestic interest rates, but the exchange value of the U.S. currency would plunge against our trading partners. That would be great for U.S. exporters but disastrous for anyone outside the U.S. who wants to sell things to American consumers and businesses. Many countries would feel compelled to intervene and offset the actions of their (and our) private citizens. The seemingly bizarre implication is that China and Japan would probably end up buying far more dollar-denominated assets after a U.S. government default than they do right now.
There are lots of good reasons why we should avoid defaulting on our debt. Fears about China and Japan aren’t among them.
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)