Why is China So Important to the US Economy?

Twenty years ago, many people believed that the economic preeminence of the United States would be eclipsed by Japan, while China was an economic backwater. How things have changed.

Since 1978, China has increasingly liberalized its economy, opening the country up to foreign investors and aggressively pursuing economic growth. It has paid off; while China remains a fairly poor country overall, the coastal regions have become increasingly wealthy as a result of globalization.

Just as manufacturing moved from the Northeast to the lower-cost South in the United States, so is it moving from the United States (and the rest of the developed world) to lower-cost China. With its abundance of cheap labor, China has allowed manufacturers to reduce their costs of production, which translates into lower prices for consumers when they go to the store. This is one of the biggest reasons for the low inflation the United States has enjoyed over the past two decades.

When Chinese manufacturers ship their goods to the United States, they get paid in dollars. They give those dollars to the Chinese government in exchange for Chinese currency. China’s government then takes most of those dollars and buys U.S. Treasury debt with them.

By doing this over and over, China’s government has become the largest single owner of Treasury debt – the bonds issued by the Federal government to cover the budget deficit. By investing so much money in Treasury bonds, China has helped reduce the interest rates the government must pay.

So over the past two decades China’s growth has benefitted the U.S. economy with both lower inflation and lower interest rates. The question now is how much longer will these trends last?