BUSINESS
12/17/2012 11:59 am ET

China Doesn't Fear The Fiscal Cliff, Buys Massive Amount Of U.S. Debt

If the fiscal cliff and the oh-so-terrifying federal budget deficit is a reason to panic about U.S. debt, then the message has been slow to reach China.

That's a sign that maybe Americans shouldn't panic about it, either.

China, America's biggest foreign creditor, continued to buy U.S. Treasury debt in October, according to data released by the Treasury Department on Monday. China added $7.9 billion to its Treasury holdings, which grew to a mammoth $1.16 trillion, the biggest foreign stockpile of Treasury debt in the world. Japan, which was years ago the biggest U.S. creditor, bought $5.2 billion more Treasurys in October, growing its holdings to nearly $1.14 trillion.

Many Americans have a perverse reaction to the fact that China is lending tons of money to them. They absolutely hate that China holds so much American debt, which they fear gives China leverage to totally get its way in the world, or something. But at the same time, many Americans are in a constant state of anxiety that China is about to stop lending them money, which would mean spiking interest rates and trillion-percent inflation, or something.

We hate you China, but don't ever leave us!

The truth is much more boring, and reassuring. China has a ton of cash to spend because of its trade surplus with America and much of the world, and because foreigners are pouring money into it, to get a taste of its runaway growth. America is its biggest customer, so extending credit to America only makes sense. Anyway, China has to put its money someplace, and Treasury debt is the world's most liquid asset. Too bad it doesn't pay any interest.

Which brings us to why China can never dump its Treasury debt all at once: That would crush the price of the bonds, and the U.S. economy, hurting China both on its investment and in its day-to-day business.

Sure, America's new annual tradition of having pointless, self-destructive arguments over our debt -- exemplified by this year's fiscal-escarpment foolishness -- certainly makes American politicians look pretty incompetent. Reason to worry, if you're lending America money.

But if the fiscal cliff actually happens, hurting the U.S. economy, that will only make China's investments in U.S. debt worth more. For one thing, America will tighten its belt abruptly. And the subsequent economic slowdown will probably send investors scrambling for the safe haven of U.S. debt, as they did during 2011's panic over the debt ceiling. Bond prices go up, China wins.

And if President Obama and John Boehner ultimately strike some sort of deal to tighten America's belt less severely while also avoiding a recession, all the better for China.

No doubt, China is diversifying its portfolio, buying companies around the world. It doesn't want to be stuck in this uncomfortable embrace with America forever. And it understands that U.S. interest rates are, some day in the hazy future, going to have to rise. Which, by the bizarre looking-glass math of the bond market, means bond prices will fall.

It's also impossible to get a full picture of what's going on with China's bond purchases. Monday's numbers are two months old, and China channels some of its Treasury purchases and sales through dealers in the U.K. and elsewhere.

But for now, China's not panicking about America's debt problem, and neither should America.

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