The Reality of the Debt War: Part 3 – China Owes the US

Many people assume that China has the US “over a barrel” because it buys so much of our debt, with the presumption that China doesn’t owe the US anything. But this is not true.

Between 1913 and 1942, the Chinese government, through various banks, issued Chinese government bearer bonds in Europe and the United States. These loans were denominated as “gold loans” and were payable in British pounds sterling and three other currencies with principle due and payable in 1960.

In 1939, the Chinese government defaulted on its sovereign debt. In 1949, the Communist Party had taken over in China, renaming it the People’s Republic of China (PRC) and the ROC government fled to Taiwan. The PRC later renounced all debt obligations incurred under former regimes while keeping the government-owned salt mines and other assets that had been used to secure the bonds, including the gold loans.

On October 29, 2003, an Order of the Executive Yuan decreed that the debts would not be repaid prior to national unification. This was to include all foreign currency bonds issued in the mainland prior to 1949 and the short term Gold Bonds of 1949. (Candace Riddle)

In 1987, when threatened with being kept out of British financial markets, China acknowledged the debt it owed from the sale of these bonds to British investors. As part of the GreatBritain – People’s Republic of China agreement on Hong Kong, the PRC agreed to pay its debt to British citizens who owned these same bonds. (Fox News)

International law has long recognized that successor governments must pay the sovereign debt of its predecessor. Not only does China owe this debt via legal tradition but also owes this debt via its acknowledgement and payment of portions of the debt in spite of its default.

As China currently holds $1.15 Trillion in US bonds as of August (CNN Money), $750 Billion could go a long way to helping us solve our problems, and could help clean the slate as far as international obligations are concerned.

From a Debt-War standpoint, China has already demonstrated that a default on debt won’t necessarily hurt a country financially, nor will it easily or readily be contested. It would be nothing for the US to simply give the debt a “haircut” or renounce the debt entirely. Especially since the US can claim back debt owed. So from a political standpoint, China isn’t as in a good position as it first seems to use US debt to influence US policy.

From a financial standpoint, the chaos from such a stance would be severe to both sides. The US would be in a position of revealing how insecure the “full faith and credit” of the United States really is. Bond rates would have to rise in order to encourage anyone at all to buy them. Or the Fed could buy them, as they have been, which means more money printing and risk of inflation / hyperinflation. Also, with interest rates pushed up, many enterprises will go bankrupt, as the current business structure cannot support itself on high interest loans. Only the low-interest loans currently being propagated by the government can keep feeding the machine. For the Chinese, they, also, would be greatly affected. The assets they hold would be greatly devalued. From an accounting standpoint, many Chinese ventures would become insolvent, as assets no longer would be sufficient to cover liabilities. Bankruptcies would follow, likely along with government bailouts. US bonds would further fall in value, as uncertainty of repayment would encourage holders to get out of them before further defaults can occur. This would result in further destruction of wealth and capital, as these assets are being used as collateral for many ventures.

Again, while this might imply that the US would be unwilling to pull the trigger on a debt default and, therefore, would be more compliant toward directives from Beijing, the fact is that China must also tread carefully on this issue, because it would have much at stake to lose as well. It, therefore, must be somewhat compliant to Washington, who can use the debt against them.

 

Some further reading (for those who are interested): (Blue Collar Muse) (Examiner) (American Bondholders Foundation)

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