Wednesday, December 27, 2006

Why China Might Have the last Word in Iraq

China always kept a low profile in the war in Iraq; they were disinterested in the matter. However, few people realise, maybe not even the Chinese themselves, that it is actually they who may well have the final say as to how and when US involvement in Iraq ends. This is because if one follows the money to see how the US is financing the war, much of it ends up in Beijing.

When governments spend more than they can earn back in taxes they have to borrow the rest by issuing debt. This debt in the US comes in the form of US Treasury bonds. The latest estimates of the Congressional Budget Office are that the US Government will spend 260 billion dollars more than it earns this year. Most of this deficit is accounted for by spending on the Iraq War which recently reached 100 billion dollars a year. We know that the war is being debt financed because most of the spending comes from emergency appropriations, when the Department of Defense asks for money from Congress outside of the usual budget procedure.

At the same time the US currently has a huge trade deficit with China. This deficit is so large that container ships often come back empty from the US on their return journey to China. Currently China sells around 100 billion dollars more goods and services to the US than the US sells to it in return, and this difference is made up for in US dollars.

The Chinese have to do something with all of their accumulated dollars. And a large proportion of them go into buying US Treasury bonds. The Chinese now hold an incredibly large share of the US public debt with almost half of all US Treasury bonds being owned in Asia. This recycles the dollars that China receives back into the US economy, more specifically into the hands of the US Government. Furthermore this willingness on the part of the Chinese to buy T-bonds keeps debt cheap for the US Government.

Now suppose for a moment that China stopped buying US Treasury bonds. This would certainly not be implausible. The Chinese central bank has often talked about diversifying its foreign currency holdings into Euros and other currencies. With the absence of an important buyer of its debt, the US would either have to raise interest rates, raise taxes or cut spending. An increase in the interest rate would raise the return on bonds, making them more attractive to other potential buyers; raising taxes or cutting spending on the other hand means that less has to be borrowed.
As the US already faces a huge burden of repayment on its existing debt, and many predict a slowdown in the US economy this year, raising interest rates may not be possible. If taxes are increased, the public will inevitably start to ask questions as to why they are being expected to hand over their money to the Federal Government, and they might not like the answer. If this Government went to the American people to ask them for more money to fight the Iraq war, there is little chance that they would be willing to pay. A swift pull out from Iraq that would drastically cut US Government spending and with it the budget deficit, might be the only option left.

In Europe we often see Americans' fear of the state and aversion to taxation with some perplexity. However in a state such as the US, which only provides for the most basic levels of public service, the majority of the government’s activities are necessarily occupied by defence. Americans know this and for them, like the British liberals of the eighteenth century, low taxation is seen as a means of keeping a violent state in check, making sure that if wars have to be fought then approval has to be sought from the purse of the public. Now it seems as though the large capacities of governments to run such deficits has long since made this check on government power obsolete. Now the power to dictate policy to the government lies not in its constituency but in the hands of its financiers. And for the US Government trying to pay for a war in Iraq, its financiers are in Beijing.


Anonymous said...

Can you link me to your sources?

An Englishman in D.C. said...

Was there anything in particular you wanted to know about? Everything in there is more or less common knowledge, but for US federal spending the Congressional Budget Office is a good source.