The huge size of the US national debt has prompted a lot of crazy thinking and crazy action. An irrational fear of the debt nearly caused the US to default this past summer during the debt ceiling fight. A misunderstanding of the national debt caused a lot of investors to mistakenly bet against Treasuries earlier this year.
So we've described misunderstanding the debt as the Costliest Mistake In All Of Economics.
But nothing we've heard so far can compare to this.
National security expert Paul Kane has an op-ed in the NYT which argues (get ready for this) that the solution for the economy is for Obama to go to China and tell the Chinese government that if they rip up our trillions in debt, we'll sellout the Taiwanese.
The Chinese leadership would be startled — for a change — if the United States were to adopt such a savvy negotiating posture. Beyond reducing our debt, a Taiwan deal could pressure Beijing to end its political and economic support for pariah states like Iran, North Korea and Syria and to exert a moderating influence over an unstable Pakistan. It would be a game changer. The deal would eliminate almost 10 percent of our national debt without raising taxes or cutting spending; it would redirect American foreign policy away from dated cold-war-era entanglements and toward our contemporary economic and strategic interests; and it would eliminate the risk of involvement in a costly war with China. Critics will call this proposal impractical, even absurd. They will say it doesn’t have a prayer of passing Congress, and doesn’t acknowledge political realities. They might be right — today.
But this idea isn't far-fetched, it's just ludicrous.
Let's just pick it apart point by point.
First, the debt isn't that big of a deal or a threat. The amount of money we're paying to service the debt, as a percentage of GDP have actually fallen over the last couple of decades. Nothing is being crowded out. Taxes are not about to surge to some suffocating, a-historical level. Interest rates aren't going to shoot up. We're not about to become Greece.
Two, and this is more important, China doesn't hold a sword over our heads. There are all kinds of reasons why we have to take China seriously, but their debt holdings aren't one of them. They can't dump our debt even if they wanted to, and as long as they wanted to trade with us (which will be forever) they won't be dumping our debt. People think the Chinese own our debt because they're our lenders. This isn't the case. The Chinese own our debt because they run a trade surplus with the US, and that surplus cash gets recycled into Treasuries. That's it.
So China doesn't have any influence over us... but if Obama did pursue something this hare-brained, then he would be telling them that they do have geopolitical control over us. And what's more, he'd be signaling to the world that anyone who accumulated enough Treasuries had some defacto control over our policy on our most important areas -- national security.
Furthermore, China would never make this trade, as Patrick Chovanec explains:
A Chinese decision to ”forgive” the U.S. Treasuries it holds as part of its FX reserves, in exchange for the U.S. abandoning its defense commitments to Taiwan, would render the PBOC hopelessly bankrupt. The central bank would lose RMB 7.2 trillion worth of assets, against only RMB 22 billion in capital, leaving a massive hole in its balance sheet. That, in turn, would hopelessly bankrupt the entire Chinese banking system, wiping out nearly half of the RMB 16 trillion cash reserve deposits they hold at the central bank (which are essentially claims on its FX reserve assets), against just RMB 2.8 trillion in paid-in capital standing behind the entire system.
The only way to avoid such a cataclysm would be for the Chinese government to write a fiscal check for RMB 7.2 trillion (the entire $1.14 trillion price of the transaction) to make them all whole, which would have to be funded by tax revenue or government borrowing. (That, by the way, is exactly how the U.S. government paid for the Lousiana Purchase. The British investment bank Barings syndicated a loan to European investors). The total bill would be roughly equivalent to China’s entire government revenue and expenditure, central and local, in 2010 and would single-handedly boost the country’s debt-to-GDP ratio by nearly 20%.
So in short, what Kane is advocating is an abdication of our strategic self-direction in exchange for extinguishing a threat (Chinese holdings of US debt) that doesn't exist.
What's scary is not that this will ever happen -- it won't -- but that the size of the debt is causing people to think loonier and loonier things. Eventually we might do something really dumb.
Read more at Business Insider.