Is the U.S. really in hock to China?

Paul Krugman has written an excellent column recently on debt and the deficit, a nice, broad "how to think about it" piece.

It's a good read all round, but I want to focus on one small aspect of it, since this question constantly comes up, usually with raised voices.

Is the U.S. in serious hock to the Chinese? ("Chinese" in this case is code for "foreigners" in that wonderful sinister sense.)

Krugman's answer, No. Here's why (my emphasis and paragraphing):

It’s true that foreigners now hold large claims on the United States, including a fair amount of government debt. But every dollar’s worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners.

And because foreigners tend to put their U.S. investments into safe, low-yield assets, America actually earns more from its assets abroad than it pays to foreign investors.

If your image is of a nation that’s already deep in hock to the Chinese, you’ve been misinformed. Nor are we heading rapidly in that direction.

Note that those are two separate reasons.

To recap: Let's say you owe your neighbor $10,000. Sounds bad, right? But only if you ignore the fact that he owes you $9,000 back. The net debt ($1,000) is a lot less frightening. (And note that only the ignorant or scare-mongering quote that first number alone.)

Now apply the second piece of information on top of the first — His $10,000 is earning 0.5% at best (since he bought U.S. Treasuries at sky-high prices and almost no yield at shorter, safer maturities).

Meanwhile, your $9,000 is earning, say, 3% (since you're invested in growth companies abroad).

If you do the math (his $10K x .005 = $50; your $9K x .03 = $270), you'll see who's got the better deal, by far. Every year this setup continues, you make $220 more than your neighbor, doing nothing. Bottom line, you're earning a cool $270 on a net debt of $1000 (that's a sweet 27%, mind you); plus you've got his $10,000 to play with.

This isn't hard to understand or remember. My suggestion — keep this logic handy the next time someone screams about Chinese ownership of the U.S. debt. If they're simply ignorant, they'll appreciate the information.

We really are losing to the Chinese, of course; but it isn't because we're selling them our Treasuries; it's because the über-rich are selling off our jobs.

GP