U.S. national debt is its Achilles’ heel, but China sees it as an opportunity

China is gradually establishing itself as a major player in what has recently been called the Global South, previously known as the Non-Aligned Movement. Over the last few decades, China has become the world’s biggest creditor of developing countries. That has prompted many to fear that it will subjugate partners through the “debt trap” and use this to establish a “hegemonic sphere of influence.”

China’s economic position is so strong that it is now considered the main threat to the U.S. dollar. It is an influential member of the BRICS+ group (which also includes Brazil, Russia, India and South Africa). This group is working to establish a multipolar world that challenges the hegemony of the West, specifically the leadership of the United States. I analyzed this issue in a previous article.

Without using the term “threat,” the U.S. administration now sees China as the “most serious long-term challenge” to the international order. It’s easy to understand why, since China’s strategic objective is to put an end to the supremacy of the U.S. dollar, the keystone of U.S. hegemony.

As a researcher in international political economy at the Université Laval, I am looking at the role China is playing in the dedollarization of the world.

The stronghold of the U.S. dollar

The supremacy of the U.S. dollar underpins American hegemony in the current international order, as French economist Denis Durand explains in his article Guerre monétaire internationale: l'hégémonie du dollar contestée? (International currency war: the dollar’s hegemony challenged?).

In addition to the fact that several currencies are linked to the dollar by a fixed link or band of fluctuation, American currency is also used in many Third World and Eastern European countries, where it enjoys a much higher level of public confidence than do local currencies. […] The United States is the only power that can incur foreign debt in its own currency.

The hegemony of the U.S. dollar over the world economy is reflected in its over-representation in the foreign exchange reserves held by the world’s central banks. The greenback still outstrips other currencies even though there has been some erosion in this.

Despite a fall of 12 percentage points between 1999 and 2021, the share of the U.S. dollar in the official assets of the world’s central banks remains fairly stable at around 58-59 per cent.

U.S. currency still enjoys widespread confidence around the world, reinforcing its status as the preeminent reserve currency. The U.S. dollar reserves of the world’s central banks are invested in U.S. Treasury bills on the U.S. capital market, helping to reduce the cost of financing both government debt and private investment in the United States.

However, the income generated for the U.S. economy by the hegemony of its dollar could also collapse like a house of cards. Durand makes this point when he writes that “the monetary hegemony of the United States […] is held together only by the confidence of economic agents around the world in the American dollar.”

There are two reasons that the world’s confidence in the U.S. dollar could decrease.

Firstly, as U.S. Treasury Secretary Janet Yellen admitted in an interview in April 2023, the United States is unequivocally using its dollar as a tool to bend enemies — but also some recalcitrant allies — to its will. This could ultimately undermine the dollar’s hegemony.

On the other hand, the U.S. debt situation, particularly its unsustainability, is a source of concern that could affect the dollar’s attractiveness as a global reserve currency.

Unsustainable debt

The U.S. dollar has been at the heart of the international monetary system since 1944, and even more so since the Bretton Woods Agreement came into force in 1959.

The Bretton Woods system was based on both gold and the greenback, which was the only currency convertible into gold; this convertibility was fixed at the rate of $35 per ounce.

That changed on Aug. 15, 1971, when, because of inflation and the growing imbalances in the United States’ international economic relations, Richard Nixon announced the end of the dollar’s convertibility into gold.

With the dollar pegged to gold, the United States’ ability to take on debt to meet public spending was limited. Under the gold-based system, where gold was the guarantor of the U.S. currency, the United States could only borrow according to the quantity of dollars in circulation and its gold reserves.

Abandoning the gold-based system gave the U.S. free rein over its debt. In 2023, the U.S. public debt reached more than $33.4 trillion, nine times the country’s debt in 1990.

This astronomical figure continues to raise concerns about its long-term sustainability. As U.S. Federal Reserve Chairman Jerome Powell has pointed out, U.S. debt is growing faster than the economy, making it unsustainable in the long term.

An opportunity for China

This is a reality to which China is clearly attuned, since it recently undertook a massive sell-off of the U.S. debt it owned. Between 2016 and 2023, China sold $600 billion worth of U.S. bonds.

However, in August 2017 China was the United States’ largest creditor, ahead of Japan. It held more than $1.146 billion in U.S. Treasuries, almost 20 per cent of the amount held by all foreign governments. Beijing is now the second-largest foreign holder of U.S. debt, with a claim of around $816 billion.

It is certainly no coincidence that before divesting itself of U.S. bonds, Beijing first launched its own gold pricing system in yuan. In fact, on April 19, 2016, the Shanghai Gold Exchange, China’s operator for precious metals, unveiled on its website its first “fixed” daily benchmark for gold at 256.92 yuan per gram.

This policy is part of China’s strategy to make gold a tangible guarantee of its currency.

China’s “Gold for Dollars” strategy

China is also selling its U.S. bonds. According to the U.S. Treasury, between March 2023 and March 2024, China sold off $100 billion in U.S. Treasuries, on top of the $300 billion it had already sold off over the past decade.

At the same time, the Middle Kingdom has replaced around a quarter of the U.S. Treasuries sold in 10 years with gold, of which it is now the leading producer and consumer. Like China’s central bank, other central banks in emerging countries continue to buy gold.

China’s appetite for gold was confirmed in 2010, when its gold reserves rose to 1,054 tonnes, from around 600 tonnes in 2005. Ten years later, in 2020, its stock of gold had almost doubled again, to nearly 2,000 tonnes. By the end of 2023, with a gold reserve of 2,235 tonnes, China will be the country with the sixth-largest gold reserve.

As a substitute for the dollar, gold enables China to store the gains from its large trade surpluses. With the Shanghai Gold Exchange, which offers gold trading contracts in Yuan, Beijing is seeking to strengthen the use of its currency abroad with the aim of establishing the yuan as the benchmark currency for the global economy.

Zakaria Sorgho ne travaille pas, ne conseille pas, ne possède pas de parts, ne reçoit pas de fonds d'une organisation qui pourrait tirer profit de cet article, et n'a déclaré aucune autre affiliation que son organisme de recherche.