Econintersect: There are many scenarios, and some of them are likely, that would cause China to stop buying U.S. Treasury debt. Some have offered grim forecasts of exploding ineterest rates and economic disaster for the U.S. if that should happen. Internationally respected economist Michael Pettis says that there are many situations that would be good for the U.S. (as well as China and the rest of the world) if China did indeed stop buying Treasuries and even if they started to sell some of them.Yes, under some scenarios U.S. interest rates could rise, but an explosion is unlikely, according to the Pettis analysis. He describes some situations in which interest rates in the U.S. could even fall, although it is hard to rationalize that they could go any lower than they are right now.
Pettis describes the situations where the need for the U.S. to finance an increasing debt would diminish. It all turns on the balance of trade. If China stops running a huge trade surplus and the the U.S. stops running a large trade deficit (the two are paired), the U.S. fiscal deficit shrink and the need for China to find a way to return dollars to the U.S. will go away – China won’t be collecting a surplus of greenbacks anymore. Read the complete Pettis analysis (with some assists from Martin Feldstein) at the GEI Analysis Blog.