Five things China can do with their US dollars

China has had a big trade surplus with the USA for years.  Although that doesn’t scare me nearly as much as it apparently scares some of our politicians, I thought it would be worthwhile to list all the possible things China could do with their dollars, and what our reaction should be to each one.  [I was asked to lift this from the comments, so here goes…]

The five things China could do with the dollars they accumulate from the USA:

1. Buy stuff from us.
Our proper reaction: "Thanks for creating US jobs."

2. Invest in dollar-denominated real assets.
Our proper reaction: "Thanks for helping us grow, and for increasing our tax base. We look forward to the extra growth, and the extra tax dollars we'll collect from you."

3. Invest in dollar-denominated financial assets such as Treasury securities.
Our proper reaction: "Thanks for trusting us to invest your money in our own growth and security; we’ll use a portion of the extra growth to pay you the 4.5% interest we promised.  Feel free to continue buying T-bonds and notes with your dollars; that's money we would otherwise have to tax away from our own people, and it also helps hold down the interest rate we'll have to pay you."

4. Hoard the dollars.
Our proper reaction: "Thanks for trusting in our currency more than yours, thereby making future inflation of our currency even less of a worry than it is now.  In essence, this means the goods you sold us turned out to be absolutely free.  Thank you very, very much."

5. Dump the dollars for another currency.
Our proper reaction: "Your masochism is puzzling.  Nonetheless, thanks for the goods you sold us before you caused the value of the dollar to drop a smidgen, inexplicably making it more difficult for us to continue buying goods from you."

Those are the only five I could think of, but feel free to suggest extras you think I overlooked.

Comments

[John F. Opie]

Hi -

All of those five are fine, but here's what one can think of given other motives:

China can use its dollars to bribe, buy and otherwise subvert the US political system, creating an environment where IP issues are ignored and advanced US technologies are given away to the Chinese, especially defense technologies that the Chinese use to gain force multipliers and tactical advantages, as well as saving billions of their own currency and years, if not decades, of time.

They're not interested in bringing the government down - they'd lose too many consumers - but rather they're interested in acquiring control of interests that politicians listen to so as to ensure that Chinese political interests become part of key sectors of the US political scene.

That's something they can use their billions and billions of dollar reserves. Not so much creating corruption and dishonesty - I spent too long in DC to think that - but certainly buying the corrupt and hiding their path so that there is little visible connection.

[pawnking]

Also, they can use the dollars to give to charities, feeding poor, starving people of the world and alieviating hunger and disease. The world's reaction "Why aren't you doing more?" Oh wait, that's how the world reacts when the US sends its dollars for the same purposes.

[Patrick]

Q:

Are all of the dollars "sent" to China thru trade controlled by the central government? I mean, do they even have the ability to "dump" the dollars?

And if so, how is the Chinese government still in debt to the tune of 22% of GDP? (cia factbook)

Please forgive me if I am missing something but I find this topic very confusing.

[Steve]

John:
Good point; I guess that would fall under the black market heading, which is technically category #1. Given that any other country could do the same thing by acquiring enough dollars, even if they don't have a trade surplus with us, I'm thinking that's more of a law enforcement, corruption control, or national security issue than a monetary problem.

[Jon Thompson]

Steve,

You forgot what my grandmother seems to think they do, namely, eat the money.

[Robert Schwartz]

China will soon have almost a Trillion Dollars of US securities. If China commits an act of war against the US or its allies, the US can forfeit those securities. Think of it as a bond for China's good behavior.

[Olivier]

Totally agree. Chinese changing their policy of Dollar accumulation amounts to shooting itself in the foot. They will therefore keep accumulating Dollar-denominated assets (T Bills) as long as they have confidence in the Dollar. This is not going to change any time soon, unless the US really gets crazy over some issues. The only thing that the Chinese can do with the Dollars they amass is to spend them in the US (and other nations accepting USDs), which will inevitably boost the economy. So trade deficits and TBills are not leakages, but temporary diversion of money which will eventually come back.
A funny thing I heard at lunch: If Chairman Bernanke decides to raise interest rates, that translates into the US government paying extra interest to the Chinese. Those Communists! Can you believe that? Do the math, a couple of years of 1% increases in the base rate means a lot of money for the Chinese if indeed they have one trillion in reserves. But then again this will benefit the US economy in return.

[Bob]

This is my angst and it is not really a monetary problem.

China has the benefit, if they choose to make use of it, of seeing the mistakes we have made and learning from them and we don't learn from them for whatever reason.

I have this nightmare of a 21st Century Demming being ignored here
and going to China. Yeah, I know it sounds farfetched and maybe it is. Call me a worry wart. But, I think China is in this game to win and we best recognize it.

[salvatorem]

It seems like the Chinese are for now buying more of our debt than any of the other choices, which in the long run should keep an upward pressure on the price of gold.

[Walker]

Olivier: Not sure if I get the joke. If Bernanke raises interest rates, he instantly devalues the Treasury securities the Chinese already own.

[rufus]

It looks like we're going to have a huge treasury "surplus" in April. This is going to wake a lot of people up to the realization that we're liable to have a "balanced" budget in 08'. The Dollar should strengthen along with T bonds.

[Ariah]

Steve: Thanks for the post!

Patrick: Good point. Some of that money is controlled by the Chinese government, but most of "China's" securities belong to its private citizens.

Robert: Wow, I hadn't thought of that! Thanks! Not that they're crazy enough to commit an act of war against us anyway, but that will make an interesting talking point with the China-phobes.

Bob: Perhaps it's not quite what you're referring to, but developing countries definitely have the advantage of skipping the experimentation phase and just going straight to the ideas and technologies that work well. I really admire South Korea's internet infrastructure, for instance, which is both superior to ours and less expensive per capita. And the way companies like Toyota took our manufacturing processes and improved on them is well known.

salvatorem: I think I'm missing something. Why should we care about the price of gold?

[Steve]

rufus:
To continue reducing the rolling 12 month deficit, April'07 needs to beat April'06 -- and it sounds like that will be the case. We'll know on May 10.

[cubicle]

"inexplicably making it more difficult for us to continue buying goods from you."

last I heard the Chinese still had their currency tied to ours. They would make their currency drop also.

[Steve]

They are loosening the dollar peg, and the dollar has been drifting down against the yuan.