By Elizabeth Factor and Mallory Factor
This week in China, President Obama is practicing a new form of American diplomacy --assurance. With China now America's largest debt holder, the president is reassuring China that their investment in the U.S. economy is secure. In analyzing the president's visit, the American media seems to have suddenly realized that America has lost the upper hand in its relationship with China. But this has been coming for a long time.
President Obama is reassuring China that America is credit-worthy so that China will not dump our debt onto the world markets. But he is also trying to ensure that China will continue to purchase our debt in the future to pay for his elaborate government initiatives like the health care bill, cap-and-trade, and other spending programs. China holds over $1.7 trillion dollars of our currency and debt, which is well over 10% of our gross domestic product--how high can our indebtedness to China go? Hard as it may be to stop going back to our foreign lenders for more support, we are just piling more dirt on a mountain that is about to come down and bury us. America would suffer if it stopped borrowing from abroad, but paying the price later will be much more devastating.
From the U.S. perspective, China's investment in our debt and economy may seem to be just what our credit-starved American businesses and financial industry need. But while creditors may not always exert influence over the debtor nation's foreign policy, they have the power to do so if their holdings of currency or debt of the other nation are sufficiently large. The fact is that by borrowing so extensively from China and other nations, we have already significantly compromised our ability to promote democracy, the rule of law, human and civil rights reforms, and environmental policy--in China and around the world.
And China and our other major creditors increasingly have the power to literally destroy our economy without destroying their own. They can do this simply by refusing to buy our treasuries, agencies and currency, or worse, by dumping what they already own on the world market, which can be likened to a"nuclear option." Without enough demand for our debt, the United States would have to either offer huge interest rates to entice the remaining market into purchasing our debt or print more money leading to a crashing dollar and massive inflation. Although each of our creditors would suffer from the decline in value of our debt and currency, they would suffer less than we would.
The "nuclear option" allows a creditor nation to present its debtor nations with terms under which lending will continue. For example, China could press the United States to buy Chinese goods over the goods of other nations or could require us to open up our markets on terms unfavorable to the United States. China could use its economic influence over the United States to curb our support for Taiwan or other allies.
Anyone who does not believe that China has a far reaching geopolitical agenda should look at their former leader Deng Xiaoping's "24 character" strategy. Deng developed this policy in the 1990s to bring China back to the prominence and power on the global stage which it had enjoyed for over 3,000 years prior to domination by Europe in the 19th century. His policy consists only of 24 Chinese characters, and continues to be quoted--and followed--by the current Chinese leadership. It is as follows: "observe calmly; secure our position; cope with affairs calmly; hide our capacities and bide our time; be good at maintaining a low profile; and never claim leadership."
China's influence over its debtors' foreign policy is growing. In 2008, the UK, another profligate Chinese debtor, stopped advocating for a free Tibet and formally recognized the legitimacy of Beijing's direct rule over Tibet. And we are responding to their pressure also. The political reality is very simple -- it is hard to press for "change" in China when we need to be concerned about maintaining Chinese investment in our economy.
The solution to this critical problem is simple and yet extremely difficult to achieve: The United States needs to stop increasing its deficits. We need to bring them down, reduce our foreign borrowing and therefore, improve our global economic standing.
And, if we are not able to change the trajectory we have begun, then what? At some point--not too far in the future, America will have a meltdown. The world will stop lending us capital and investing in our economy, and the value of our debt will crash. Our financial pressures will change our American way of life-- in small ways at first and then, in big ways. Even our current reduced level of consumption--cars, electronics and consumer goods--will no longer be possible. And this crisis will lead to many unforeseeable shifts in our political alliances, domestic policies and business practices.
And it will no longer be the U.S. that will be speaking softly and carrying a "big stick." On his visit to China, the president went through the motions of addressing human rights and environmental issues to appease his base at home, but even he must realize that his remarks will have no impact on Chinese policy.
Soon, American presidents will not even mention human rights violations or other issues for fear of offending China or our other important creditors. We are already learning that we cannot promote democracy, civil rights, environmental policy, and a fair legal system to our creditors. At best, we may be able to preserve and defend these principles at home.
Instead of reassuring China, our president needs to be reassuring the people of our nation that he understands the connection between overspending and our future prosperity. Looming debt has made increases in spending simply impossible to consider and yet, Democrats in Congress and the White House seem to be throwing America "under the bus" with its rampant over-spending. President Obama needs to take steps immediately to halt our reliance on foreign borrowings and to ensure that America and our way of life are preserved.
Elizabeth Factor is an international tax lawyer and former investment banker.
Mallory Factor is the co-chairman and co-founder of the Monday Meeting, an influential meeting of economic conservatives, journalists and corporate leaders in New York City. Mr. Factor is a well-known merchant banker and speaks and writes frequently on economic and fiscal topics for news stations, leading newspapers and other print and online publications. Mr. Factor writes frequently for the Fox Forum and is seen regularly on Fox News Channel. Mr. Factor can be reached at mallory.factor@malloryfactor.com
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