Debt and Foreign Policy

Last week the big news in Sino-US relations was the harassment of a US spy ship near a Chinese nuclear submarine base by the Chinese Navy. I use the term harassment a bit tongue in cheek since it consisted of mooning the American sailors rather than the sort of menacing behavior we might normally expect.

Anyway it should sound familiar to those of us at least old enough to remember when Nirvana was still recording because China through a similar hissy-fit over a US spy plane in the first few months of the Bush administration. That incident turn more serious since our people were essentially held hostage for a week and a half, but ultimately cooler heads prevailed and we went back to patriotically buying shoes made by Chinese slaves. I should point out that in both cases our spying was on the up and up since they were in international airspace or waters, however imagine how nervous we would be with Russian ships cruising around 30 miles off the Pacific coast.

That said, the incident drowned out coverage of a much more disturbing and potentially dangerous bit of diplomatic saber rattling coming out of Beijing. Premier Wen Jiabao demanded that the US "guarantee the safety" of China's $1 Trillion in US debt.

"We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets… To be honest, I am definitely a little worried."

Make no mistake; this is a direct shot across the bow. Combined with the spy ship incident it's clear they are testing President Obama's resolve and demonstrating their position of strength. With Secretary of State Clinton just back from her Friendship "Please please please keep buying our debt and we'll stop talking about human rights" tour, the intent couldn't be more clear.

So how did they end up with so much of our debt in the first place? It's actually a strategy China has employed to keep their currency deflated compared to the US. Since we have a trade deficit with China they end up with extra US dollars. Most countries would use this to build up their economies, make new investments, and raise the standard of living for their people. However, that would mean their currency would rise relative to the US making Chinese manufacturers less cheap. And let's face it, cheap is the only attractive thing about dealing with the Chinese government. Not being concerned in the least for the average Chinese worker gives their government an opportunity to pursue a strategy most other nations would never think of employing. So to keep their currency from rising they buy US Treasuries by the boatload. This keeps their currency rising and falling with our own. It also helps out the US because an eager buyer for our debt means interest rates remain low and cheap debt helped fuel our consumer driven economy.

However, this also gives China enormous leverage over the US. How? China can wreck what's left of our economy by selling off all their Treasuries at once, sending the dollar into a freefall. There's actually precedent for this sort of behavior. During the Suez Canal Crisis in the 50's the US was demanding that the United Kingdom cease hostilities (isn't it cute that we used to try to keep the Brits from going to war?) Upon their refusal President Eisenhower announced that he would sell US reserves of the Pound as well as their debt. The threat had immediate effect and the crisis ended. How could we respond to some action by China if they threatened to sell off our debt crashing our economy? Is Taiwan's independence more or less important to us than another Great Depression?

In this regard our political leadership, Democrat and Republican, undermines US foreign policy and security by refusing to bring spending and taxation into balance. They do so at the behest of unrealistic voters who alternately want cut taxes from Republicans and increased spending from Democrats. Perhaps our current situation is a good time to reevaluate those conflicting demands.