Exactly How Much Is the U.S. Debt to China?:
The U.S. debt to China changes each month, depending on how many Treasury notes the Chinese government buys or sells. In August 2013, China owned $1.268 trillion in U.S. debt. China now owns 23% of the total of $5.59 trillion held by foreign countries. The rest of the more than $17 trillion debt is owned by either the American people, or by the U.S. government itself. For more, see Who Owns the U.S. National Debt?.
China has held more than $1 trillion in U.S. debt for the last three years. That's when the Treasury Department changed how it measures the debt. Before July 2010, Treasury reports show China held $843 billion in debt. This makes it difficult to do long-term comparisons. (Source: Major Holdings of U.S. Treasury Securities)
How Did China Become America's Biggest Banker?:
China is more than happy to own a large portion of the U.S. debt. Owning U.S. Treasury notes helps China's economy grow by keeping its currency weaker than the dollar. This keeps products exported from China cheaper than U.S. products, creating jobs for the Chinese people.
The U.S. allowed China to become its biggest banker because the American people enjoyed low consumer prices. Selling debt to China allows the U.S. economy to grow by funding federal government programs. It also keeps U.S. interest rates low. However, China's ownership of U.S. debt is shifting the economic balance of power in its favor.
Why Does China Own So Much U.S. Debt?:
China makes sure its currency, the yuan, is always lower than the U.S. dollar. Why? Part of its economic strategy is to keep its export prices competitive. It does this by holding the yuan at a fixed rate compared to a basket of currencies, the majority of which is the dollar. When the dollar falls in value, the Chinese government uses extra currency to buy Treasuries, which increases demand for the dollar, increasing its value. In addition, China promises to redeem dollars for yuan at the fixed rate. Obviously, it must keep a good supply of dollars, as Treasury notes, in reserve.
Holding U.S. Debt Gives China Political Clout:
China's position as America's largest banker gives it some political leverage. Every now and then, China threatens to sell part of its debt holdings. It knows that, if it did so, U.S. interest rates would rise, which would slow U.S economic growth. For example, in June 2009 China called for a new global currency to replace the dollar, which is used in most international transactions. China does this whenever the U.S. allows the value of the dollar to drop, which makes the debt China holds less valuable.
What Would Happen If China Called In Its Debt Holdings?:
First, China would not call in its debt all at once. If it did so, the demand for the dollar would plummet like a rock. This dollar collapse would disrupt international markets worse than the 2008 financial crisis. China's economy would suffer along with everyone else's.
It's more likely that China would slowly begin selling off its Treasury holdings. Even when it just warns that it plans to do so, dollar demand starts to drop. This hurts China's competitiveness, as it raises its export prices, so U.S. consumers start buying U.S.-made products instead. China must further expand its exports to other Asian countries, and increase domestic demand, before it can call in its U.S. debt holdings.
China's Debt-Holder Strategy Is Working:
Because of its ability to ship low-priced goods, China's economy has grown around 10% annually for three decades. It's currently the third largest economy in the world, after the U.S. and the EU. China's annual GDP for 2012 was $12.4 trillion. In 2010, China became the world's largest exporter. (Source: CIA World Factbook)
China needs this growth! Its GDP per capita was only $9,100 per person, compared to $49,800 per person for the U.S. This low standard of living allows China to attract overseas manufacturers to outsource jobs by paying its workers less. Therefore, despite its threats, China will continue its position as the world's largest holder of U.S. debt. (Article updated November 5, 2013)