However the idea that China could simply fail to show for a Treasury auction and collapse our economy is utter nonsense. To begin with, just because you’ve been paid in dollars doesn’t mean your only use for them is to give them back by purchasing debt. Nor is China even remotely the only holder of US external public debt. If China failed to show up, interest rates would rise some, but they’re not the only nation that buys US debt either–most US Treasury debt is sold domestically.

Likewise with attempting to use currency reserves. They’re ultimately only good for buying US goods and services. Get too hostile rowdy, trade restrictions come down, and the money has to go through third parties to do you any good, but you have to split the take with the third parties. IOW, you end up not getting remotely near your money’s worth.

To drive a point home, the doom-criers of debt invariably do NOT present national debt in context. “National debt” has two major components, and only one of them is involved here. The first component is intra-governmental holdings, money owed by the government TO the government, such as the SS/Medicare “trust funds.” That’s almost entirely driven by (and composed of) political promises regarding future benefits. The other portion–debt held by the public–is what really counts, and that’s actually declining as a percentage of GDP right now, because the economy has grown faster than the public debt. But the doom-criers of debt ALWAYS present debt as an absolute number AND as the total of the two, not as a percentage of income or assets, and not separated into external discretionary versus intrnal program debt.

What has shifted is that a larger portion is being held externally, foreign rather than domestic. That’s an inevitable result of globalization, and brings its own set of problems and benefits, but it’s not inherently bad.

Not to mention that US Gov’t debt held by the public is actually a bit on the low side in comparison to other nations. Most of Europe would be thrilled to have public debt at our %-of-GDP levels. Not that it would be a bad thing for us to owe less outside of our borders, or less overall, but little Timmy hasn’t exactly fallen down the well.

And of course it’s more complicated than that, but government-debt paranoia isn’t real good on complicated. You must panic. You must panic now! Do not think about it, just panic….

So Tully is right, China can’t take us down financially without doing far worse to themselves.  But there is an important caveat — while they can’t take us down, their ownership of our debt does give them important leverage that could be used in a crisis situation (i.e. over Taiwan) to inhibit the United States by threatening to dump U.S. Treasury securities or at least stop buying them.

So while I don’t buy the most catastrophic scenarios of a Chinese financial war against the United States, I cannot share in just blowing off the significance of the problem.

What are they going to do with it, norm? Eat the bank statements? Who they gonna sell to if we’re not buying? They’ve pegged their currency to ours–what happens to theirs if they crash the dollar? When countries become tied economically their incentives to screw each other economically diminish. China imports almost half their consumption, the US about 15%. China exports for 28% of their GDP, the US about 11%. Their real GDP is less than half of ours, and their currency reserves are good for about a month worth of import purchases–at today’s exchange rates. Who gets hurt more in a currency war? Which country can weather one better? Hint: We’d have a recession–but they’d make North Korea look prosperous by comparison. We’d change politicians the next election. They’d be eating theirs.

No, I don’t think China is gonna go for it. But it is fun to listen to people rant.