13. China's heavy buying of U.S. debt has lowered the cost of money in the U.S. In the first half of 2004, China's total foreign exchange reserves topped $460 billion. In size, that puts China's cumulative dollar account at roughly equal to a third of its gross domestic product. If China simply spent its dollars, it would flood the world market with American currency and drive the dollar down. But China, no fool, is not interested in pushing the dollar down. So instead of selling its dollars, it lends them back to the U.S.
China keeps tight wraps on the value, composition, and trading of its portfolio, but Wall Street commonly assumes that the country owns a large amount of high-grade U.S. corporate bonds, intertwining its national fortunes with America's blue chips (many of them the same corporations reaping fortunes in China itself).
China also has almost certainly built a large stake in the market for bonds issued by Fannie Mae and Freddie Mac, the companies that buy home mortgages from banks and thrift institutions and resell them as bundled securities. This means that billions of dollars' worth of investments belonging to the Chinese are plowed indirectly into the American real estate market, and that an ever-increasing share of Americans' mortgage payments pour into the coffers of the government of China.
As long as China is an aggressive lender, Americans -- whether borrowing for their own private purchases or acting in the roles of taxpayers -- can borrow money at lower rates than they would otherwise have to pay. Much of the recent boom in real estate prices in America, especially in the East and West Coast markets, is attributable to these low rates.
14. Americans and Chinese have become reliant on each other's most controversial habits. The Chinese need a low-priced currency to keep their export machine going and create jobs. But maintaining the yuan's low price also means that Chinese consumers are stuck with a currency that would otherwise buy more for them on the world market. China's diligent savers suffer too since their bank deposits are tied up in accounts that earn low government-mandated rates of return, as the government, in effect, siphons off money from savers to maintain its currency peg.
The people of China are indirectly subsidizing the insatiable shopping of Americans.
Relatedly, China's vast export earnings earn less than they ought to when they are invested in U.S. debt securities that offer modest yields, when investments in the Chinese economy can return 10 times as much (albeit on riskier terms). Seen from that view, the people of China, who earn on average just one-fortieth what Americans do, are indirectly subsidizing the insatiable shopping of Americans, who acquire ever more goods at the same time that Chinese consumers are hampered from buying goods from abroad.
The obverse of this peculiar relationship is that China lends America all the money it needs to spend itself silly. The cycle of codependency, which former U.S Treasury Secretary Lawrence Summers labels a "balance of financial terror," isn't sustainable. The U.S. cannot take on ever-bigger debt and amass huge trade deficits indefinitely. In the worst scenario, the U.S.'s willingness to fritter away its national wealth to finance private consumption and unproductive government spending would extract a permanent price on the economy, sending the U.S. in a downward spiral that would be hard to escape.
Thus do the routes to prosperity chosen by China and the U.S. put both countries at risk. Without the U.S. to buy Chinese goods, China cannot sustain its growth; without China to lend money to the U.S., Americans cannot spend. Without the twin engines of the U.S. and China stoking the fortunes of other nations, the rest of the world might also sputter.
How can the U.S., perhaps with its traditional allies, adjust to a competitive challenger that has strengths unlike any other that America has faced? Are the transfers of talent, technology, and capital part of an inevitable dynamic? Or does the U.S., or any other country, have the power to shape a future in which everyone prospers?
Americans looking for answers and action must also find a way to move America's leadership to see China's rise as every bit as worthy of national attention as the rumblings in more obvious political hot spots. While all eyes turn to the so-called clash of civilizations between Islam and the West, China will have the more profound impact on the world in the long run. And yet, despite occasional misgivings offered in factory towns and tariffs slapped on imports at the height of campaign season, American leaders tend to view China's rise as the fulfillment of a free marketer's dream, where global investors will shepherd the country into wealth, democracy, and peaceful interdependence with the rest of the free world.
It is a lovely theory, and it may ultimately be true. There is, however, no evidence upon which to base such a prediction. Which exactly of the world's large, highly nationalistic, dictatorial, Communist-capitalist countries offers a historical analogue? Answer: There is no such country.
