How China helps pay for Medicare, U.S. aircraft carriers

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Vihe aircraft carrier USS George Washington during Annual Exercise 2013, at sea in this November 27, 2013 handout from the U.S. Navy. The USS George Washington took part in a joint military naval drill with Japan on Thursday in waters off southern Japan, just days after it participated in humanitarian relief operations in the Philippines. More than 20 ships and 7000 U.S. personnel participated in this year's Annual Exercise 2013 which aims at strengthening ties between the United States Navy and the Japan Maritime Self Defence force. While the U.S. Navy would not confirm the exact coordinates, they were able to say the event took place, at one point at least, some 300 kilometers (186 miles) south east of Japan's southern most the islands of Okinawa. This is in the general vicinity, though not within, the new airspace defense zone which China newly established last week. Picture taken November 27, 2013. REUTERS/Mass Communication Specialist Seaman Liam Kennedy/U.S. Navy/Handout via Reuters (MID-SEA - Tags: DISASTER MILITARY POLITICS MARITIME) ATTENTION EDITORS - FOR EDITORIAL USE ONLY. NOT FOR SALE FOR MARKETING OR ADVERTISING CAMPAIGNS. THIS IMAGE HAS BEEN SUPPLIED BY A THIRD PARTY. IT IS DISTRIBUTED, EXACTLY AS RECEIVED BY REUTERS, AS A SERVICE TO CLIENTS

Chinese holdings of U.S. federal debt hit a new record high toward the end of 2013. We should probably be grateful.

At the end of November (the latest data available), China held $1,317,000,000,000 in U.S. Treasury securities. If all those zeroes make your head swim, that’s about $1.32 trillion, which exceeds the prior record, from 2011. China has been the largest foreign holder of U.S. debt since 2008, when it overtook Japan, which is now No. 2.  

Chinese holdings of U.S. debt strike some people as a national-security vulnerability, but that’s largely a myth fed by fear-mongering xenophobes. For one thing, the debt held by China only amounts to about 7.6% of the entire $17.2 trillion in U.S. debt. About two-thirds of the national debt is held in the United States, with roughly 45% of that held by government trust funds and other federal agencies, much of it taxpayer money slated to be spent on Social Security and other entitlements. Overall, Uncle Sam’s portfolio of creditors is pretty well diversified.

Borrowing from all sources, including China, also helps Washington pay for more programs than Americans finance on their own through taxes. A trenchant irony of China’s lending to the United States is it helps pay for aircraft carriers, fighter jets, missiles and other military hardware that would menace China if there were ever a standoff between the two nations.

"One big pot of cash"

Funds from China also help pay for Medicare, highways, education grants, prisons, food stamps and most other things the federal government spends money on. A few programs — most notably, Social Security — have a dedicated source of funding. Medicare is partly funded that way, but money for some parts of the popular healthcare program for seniors comes from the Treasury Department’s general fund. For the most part, money from taxes and borrowing goes into the same pool at the Treasury, with no distinctions on how dollars from different sources are spent. “Whether the payments are derived from debt or taxes, it’s all one big pot of cash,” says Deborah Lucas, a finance professor at MIT’s Sloan School of Management.

China’s holdings of U.S. debt may actually be a bigger worry for China than for America. “When people ask ‘how bad would it be for the United States if China withdrew its money,’ the answer is, 'how bad would it be for China if the United States went bankrupt?'” says Richard Kogan of the Center for Budget and Policy Priorities. “China has a big stake in the solvency of the United States. They want us to pay all their principal and interest and keep buying the stuff they make.”

There’s little or no evidence, in fact, that China’s foreign-debt holdings have ever been used for political purposes. China mostly invests its reserves the way any nation seeking financial stability would.

The vast scale of borrowing by the U.S. government is a different story altogether and a legitimate worry. Washington has made halting progress on its debt recently, with the annual deficit dropping from $1.1 trillion in 2012 to $680 billion in 2013. That should fall to about $560 billion this year, according to the Congressional Budget Office, and perhaps lower if the economy exceeds expectations and tax revenues rise.

There’s still no plan, however, for addressing federal budget gaps that are expected to explode starting around 2020, as spending on retiring baby boomers skyrockets. With luck, China will still have a lot of money to invest by then — and remain in an accommodating mood.