Dr. L. Venkateswaran
May 17, 2020


The Covid-19 pandemic has led to renewed tensions between the US and China over its origin and spread. This follows a brief thaw in friction after both sides held lengthy negotiations over a protracted trade dispute since 2017. US officials, amidst the current crisis, continue to insist that they are closely watching China’s deliverables on its promises as part of a phased bilateral deal to provide more access to its market and purchase more products from the US. If these deliverables are left unfulfilled, there is a significant possibility that the US will renew imposing more tariffs on Chinese products. 

In this context, how have China-US economic relations evolved over the years? Does its significant debt holdings in US treasuries provide leverage for China? Does the US have options to offset any such leverage by China? 

China launched its economic reforms in the late 1970s to generate higher economic growth. This would provide material benefits for its people and nullify the pressure for political reforms, thereby ensuring the stability of the system i.e., the one-party system under the CPC. The economic reforms, with “Chinese characteristics”, were unlike those undertaken by other countries. China opened its market not to allow imports but to drive exports into other countries. 

To support this export-driven model, China created a supporting environment internally. The low standard of living, along with the use of prisoners, allows Chinese companies to employ cheap labor. China has developed cities with low-rent housing to attract labor, particularly from rural areas. The Chinese government also spends massively, particularly on state-owned companies, to fuel exports. The government has also funded the construction of railways and other infrastructure to support growth. China is the world’s third-largest importer. It primarily imports raw commodities majorly from Latin America and Africa, such as oil and other fuels, metal ores, plastics, and organic chemicals in return for investing in their infrastructure. It is also the world’s largest importer of aluminum and copper. All this has allowed China to manufacture products cheaper and increase its competitiveness in the foreign markets, making it the world’s largest exporter since 2013.

The low price of products and cheap labor in China has also lured overseas manufacturers, in particular American companies, to outsource jobs or send raw materials to China. Hence, China does large scale manufacturing for companies from the US. In this way, a lot of China’s exports are actually produced by American companies. Companies based in the US have been unable to compete with China’s low production costs, thus leading to increased unemployment in the US. Its manufacturing employment as a share of total employment has declined steadily from 28 percent in the 1960s to 8 percent in the 2010s. This has corresponded with a decline in US competitiveness in the global marketplace. 

China primarily exports electrical and other types of machinery, especially computers and data processing equipment, as well as optical and medical equipment. Interestingly, these commodities constitute nearly 33 percent of all global US imports. This presents the complementarity between US domestic requirements and Chinese exports. Despite bilateral trade reaching US$ 559 billion, the US has a burgeoning trade deficit of US$ 345 billion with China in 2019. As China undergoes an economic slowdown, it will have global implications, including for the US.

China holds the Renminbi at a fixed rate compared to a currency basket, of which the majority is the dollar. This ensures that its export prices are competitive. China has partially fixed its Renminbi to the dollar using a modified fixed exchange rate. When the dollar loses value, China buys dollars through the US treasury to support it. In this way, the Renminbi’s value is always within the targeted 2 percent range. China has bought so many US treasury notes that it is now the second-largest lender to the US government behind Japan. The US debt to China stood at $1.09 trillion by 2019, which amounts to over 30 percent of the total public debt owned by foreign countries. 

Since the initiation of the US-China dialogue in 2006, the People’s Bank of China (PBOC) has taken measures to strengthen the Renminbi’s value against the dollar. The Renminbi has increased by 2-3 percent annually between 2000 and 2013, and since 2005 its value has risen by 33 percent against the dollar. Amidst a sustained economic slowdown, which has impacted its exports, China is now attempting to expand its exports to other Asian countries and increase domestic demand simultaneously. The dollar has strengthened by 25 percent since 2014 since China has allowed for the value of the Renminbi to decline so that its exports can compete with Southeast Asian companies, which have not tied their currency to the dollar. In the meantime, the Chinese leadership is making efforts to sustain economic growth through stimulus. 

This has given way to speculation that China has gained political leverage over US fiscal policy, particularly if it withdraws its debt holdings. By buying treasury notes, China has helped in keeping US interest rates low. This has helped fuel the housing boom in the US, leading ultimately to the subprime mortgage crisis. If China stops buying US treasury notes, interest rates and borrowing costs will rise, throwing the US and the world into recession. This would decrease demand from US consumers for Chinese exports. Such a move could also reduce the value of China’s forex reserves, and finding an alternative investment with good returns is also difficult. Hence it is in China’s interest to keep buying US treasury notes. 

However, China does have political leverage due to its debt holdings of US treasuries. Chinese media reports and scholars have been discussing the possibility and methods of dumping its debt holdings in US treasuries amidst the trade conflict. It has sold, for the first time in 2.5 years, its earliest held US treasuries in March 2019. China, once in a while, threatens to sell part of its debt holdings whenever the US puts pressure on raising the Renminbi’s value. Whenever the US allows the value of the dollar to drop, which makes China’s debt holdings of less value, China often responds by calling for a new global currency to replace the dollar, which is used in most international transactions presently. China’s debt holder strategy has been successful, thus far providing it political leverage over US fiscal policy. 

This must be viewed from the overall strategic prism where China is aiming to replace the US as the world’s leading power. It has serious global implications as China’s intentions to assume leadership is perilous given its penchant for secrecy and control; one-party dictatorship; crackdown on dissent within civil society; violation of its ethnic minorities rights and its growing assertiveness in its immediate neighborhood and the larger region. 

Comparatively, India’s huge market, intellectual capital at cheaper costs, and growing infrastructure and connectivity networks can be tapped further by American companies as a buffer to offset the negative impacts of Chinese debt withdrawal on the US economy. Outsourcing has already helped American companies to tap into India’s intellectual capital for a cheaper cost and retain competitive edge and innovation advantage. India has contributed significantly to enhance the US economy. The Indian diaspora is the wealthiest among ethnic groups in the US, according to the US census data of 2010. It includes a large number of professionals, business entrepreneurs, and educationists occupying top leadership positions and working in sensitive government-owned labs, including nuclear labs. Indian companies have significant operation presence and tangible investments across all the states in the US and are creating jobs for nearly half a million American people. Indians are second among places of origin for students coming to the US, accounting for 12 percent of the foreign student population, which contributes nearly US$ 25b to the US economy.

India’s defense market presents lucrative opportunities for American defense manufacturers, which will create more jobs and contribute further to the US economy. Over the next decade, India is likely to spend as much as US$ 100 billion to procure defense equipment. This may change with the recent assertion of ‘Atmanirbhar Bharat’ by Prime Minister India. The P8I, C130J, and C 17 Globe Master aircraft deals recently have created 40,000 jobs for American people.

*** The author has completed a Ph.D. from Jawaharlal Nehru University under the guidance of Prof. Chintamani Mahapatra, Rector and Faculty at US Division, CCUSLAS, SIS, JNU ***