China Demonstrates That The Welfare State is a Major Threat To U.S. National Security

by | Jul 3, 2018 | Asia

China demonstrated that our government debt, built over half a century of excessive welfare-state spending, is a major threat to our national security.

House Speaker Paul Ryan is wrong when he thinks we can grow defense spending without entitlement reform. When I made that point last week, the Chinese government proved me right: with a mere whisper about reconsidering their investments in US Treasury bonds, Beijing rattled Wall Street and — if ever so briefly — raised our interest rates.

In a financial heartbeat, China demonstrated that our government debt, built over half a century of excessive welfare-state spending, is a major threat to our national security.

It was on January 10 that a Bloomberg report explained how “senior government officials in Beijing … have recommended slowing or halting purchases of US Treasuries.” Officially, the recommendation is motivated by changing dynamics in the government debt market, such as the end of the Federal Reserve’s Quantitative Easing and similar policies in Europe.

Unofficially, however, the Chinese whisper could very well have been a muscle-flexing move. From a US national-security viewpoint it was perfectly timed. It came just as Congressional budget talks kicked into high gear and Republicans raised demands for more defense spending. The message from Beijing was that if they wanted to, they could stop our efforts at increasing defense spending, and even disrupt our ability to maintain current levels of defense spending.

China’s government owns approximately $1 trillion worth of US treasuries. That does not sound like much, given that our government debt exceeds $20 trillion, but it is in fact more than what the Federal Reserve bought in one year during its Quantitative Easing programs.

If the Chinese chose to dump their treasury bonds onto the global debt market, it would send a shockwave through the US economy.

To get an idea of just what damage China could do, consider the rise in interest rates here in the United States since the Federal Reserve began phasing out Quantitative Easing in late 2014. From January 2015 to January 2018:

·         the Federal Reserve’s benchmark rate, the federal funds rate, has increased by 1.4 percentage points;

·         the interest on a 10-year US Treasury bond has increased by almost 1.3 percentage points.

These increases are slow, gradual, and the result of predictable market adjustments by big institutions. A disruptive event would cause interest rates to rise much faster.

And higher. When debt investors gradually lost confidence in the Greek economy in 2009-2010, the rate on a 10-year Treasury bond increased from 4.6 percent in September 2009 to 11.3 percent a year later. Again, this was not the result of a single, major shock, but the cause of a gradual weakening of investor confidence.

A Chinese bond shock would be a much more dramatic event, with very serious repercussions for the federal budget.

As of 2017, the interest cost on the federal debt was $457 billion. This equals an interest rate of 2.26 percent on the entire federal debt. If the interest had been 0.3 percentage points higher, the same level as it was in 2013, interest payments would have exceeded $518 billion. That would have topped federal spending on income security ($514 billion).

At an average interest rate of 2.75 percent, the total interest cost would have been $556 billion, a smidgen more than the $546-billion budget for the Department of Health and Human Services.

With a 3 percent rate, the US Treasury would have had to spend $607 billion on interest — $4 billion more than the entire Department of Defense budget.

A Chinese bond shock would send interest rates rising much higher than 3 percent. How high? It depends on what response the US government would muster, how fast the Federal Reserve could counter with an emergency Quantitative Easing program and balance up the market. Together, the Treasury and the Fed would probably be able to stabilize the market enough to make extreme interest rates a temporary phenomenon.

However, any such rescue operation would come with a steep price tag. The Fed would be forced back into Quantitative Easing, now with a commitment as perennial as the federal deficit. With the monetary printing presses working overtime again, the dollar would weaken, causing a surge in inflation expectations. Oil prices would rise — and rise rapidly — reinforcing expectations of a supply-side inflation shock.

Suppose interest rates were to stabilize around 5 percent, a conservative estimate. At that level, the cost of interest payments on our government debt would exceed $1 trillion per year. At 6 percent, the debt would almost pass Social Security as the largest item in the federal budget.

It does not take an economics genius to realize what this would do to the US economy: business investments would tailspin; unemployment would rise rapidly, putting severe stress on all kinds of welfare programs; consumer spending would grind to a halt; and tax revenue would plummet.

Faced with a runaway deficit, Congress would have to resort to panic-driven spending cuts, the likes of which we have only seen in hard-hit countries in Europe and Latin America.

It would be impossible for Congress to maintain defense spending at current levels, let alone increase it.

Regardless of whether it was the Chinese government’s intent, their whisper about reconsidering their investments in US Treasuries was a stark reminder of just how big of a national-security threat our national debt has become. Since the debt, in turn, is the accumulated excess cost of our welfare state, the root of the problem is right there, in the idea that government should engage in economic redistribution.

Until Congress decides to stop playing do-gooder with the American people, it will continue to expose itself to the risk that comes with foreign, and potentially hostile, governments can hold a sword over the head of our country’s economy.

Made available by the American Institute for Economic Research. Visit their website at

Sven Larson, Ph.D., is an economist who writes for the American Institute for Economic Research.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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