Chinese Premier Wen Jiabao

Speaking at his annual press conference, Chinese Premier Wen Jiabao expressed concern about the outlook for U.S. government debt: “We have made a huge amount of loans to the United States. Of course we are concerned about the safety of our assets. To be honest, I’m a little bit worried. I would like to call on the United States to honor its words, stay a credible nation and ensure the safety of Chinese assets.

China does hold $1.946 trillion in foreign-exchange reserves, two-thirds of which is believed to be held in Treasury bonds and other agency debt (think Fannie Mae securities). But as the Wall Street Journal’s Andrew Peaple explains, China’s status as the largest buyer and holder of our debt does not really empower them much:

Rhetoric aside, it bears repeating that China will find it hard to make a meaningful shift out of Treasurys, the prime current channel for investment of its $1.95 trillion foreign exchange reserves. Some say China could switch holdings into gold — but that market’s highly volatile, and not large enough to absorb more than a small proportion of China’s reserves. It’s not clear, meanwhile, that euro, or yen-denominated debt is any safer, more liquid, or profitable than U.S. debt — key criteria for China’s leadership.

Most pertinent of all, even if China decided to sell off some of its U.S. Treasury holdings, it would scarcely be able to dump that in large blocks. And a partial selloff would surely lead to a slump in the Treasury market, eroding the remaining value of China’s portfolio. … But whatever the rhetoric, Wen and his Chinese leadership colleagues, like the rest of us, can do little but watch, wait and worry about the state of the U.S. economy.

Heritage fellow Derek Scissors made a similar point in testimony earlier this year:

One area of concern in the U.S. is Chinese financial influence. As noted, Chinese investment is largely involuntary, a function of having a great deal of money and no place else to put it. This refines the usual analogy of banker and customer to one where the banker has a choice of “lending” to one particular customer for the better part of her business, or crafting an exceptionally large mattress. The influence is mutual.

Who needs the other more varies with American and international financial conditions. The more money the U.S. borrows, the more the American economy needs the PRC. The more desirable Treasury bonds are, the more China needs us. The U.S. is planning to run a federal deficit of over $1 trillion but there has been a flight to quality and American Treasury bonds are highly desired. There is balance on this score. The PRC can exercise little or no leverage over American policy by virtue of its purchase of our bonds.

There is future danger in the possibility that we will run sustained, gigantic deficits. The longer these last, the more likely it is that U.S. treasuries will become relatively less attractive, thereby tipping the balance of influence toward China. The U.S. could come to need Chinese purchases more than the PRC needs American bonds, yet another argument to control the federal budget.

The problem is not our current level of debt. China can and will consume that level for now. What will hurt us is sustained exploding deficits. Right now, everyone wants treasuries. But China’s trade surplus with us is not going to grow as fast as the Obama Administration’s budget is predicted to. If we still are selling in large quantities to China five years from now and others don’t want our treasuries, then we’re going to have to compensate them with a higher yield … if they’ll take them at all.