When China took its decisive turn toward capitalism in the later Seventies, it chose the time-honored development path of linking its currency to the dollar and concentrating on export-oriented industries aimed at the US market.  Like its predecessors down this road, it has chosen to keep its profits in dollars, to prevent an otherwise steady stream of sales of the US currency from altering the favorable exchange rate on which at least some of its overseas commence is based.

China’s industrial success has resulted in its becoming the largest foreign holder of Treasury securities, with a value of about three-quarters of a trillion dollars.

Recently, China has been complaining publicly that excessive government spending in the US can potentially pose a threat to the worth of China’s Treasury holdings, either through currency depreciation or higher interest rates.   Of course, the last thing China wants is a sudden outbreak of fiscal responsibility in the US, either by the government (fat chance!) or the population at large.  That would translate into sharply reduced demand for Chinese goods and by doing so would realize Beijing’s greatest fear–social unrest triggered by job losses and rising unemployment (the Financial Times cites recent problems among state-owned steel companies, even in good times).

How are we to interpret these remarks, then?  I think Premier Wen gave a hint a week or so ago when he made the first formal statement that, as part of China’s “going out” policy, the country wants to use its some of its dollar holdings to buy foreign physical assets.  In itself, this isn’t a startling statement.  If you’re worried about inflation. the last thing you want to hold is conventional bonds, which afford no protection.   You want to be a borrower (at fixed rates) or hold stocks or physical assets instead.  To the degree that China might buy ownership interests in producers of industrial raw materials, it strengthens its supply chain at the same time.

An entity (government, corporation or individual) living beyond its income can either reduce spending or finance current consumption by borrowing or selling assets.  In particular, it would make sense for the US to allow/encourage China to buy US assets to reduce its Treasury bond holdings.  These might be government-owned things, like roads, or buildings or transport facilities (what about Amtrak?).  Even if they’re not, such sales would help remove an unhappy holder from the Treasury roster.  And history suggests that foreigners tend to pay ludicrously high prices for US assets (think:  Japan in the late Eighties), benefiting US sellers–to say nothing of the capital gains taxes transactions generate.

Nevertheless, despite the fact that an American getting a crazy-high price for an asset he owns is a good thing, and the fact that you’d think a holder of US bonds should be able to use them for something, Washington has generally blocked asset sales to China for what appear not to be valid economic or national security reasons.

I think this is the issue Premier Wen is trying to put back on the table–a potentially serious threat to the Treasury market will go away if Washington allows China to make acquisitions in the US.