Even before gridlock in the Senate blocked a plan to tackle chronic budget deficits, China sent an unmistakeably clear message that it is not willing to put up with the federal government's addiction to borrowing forever.
The latest Treasury report is a sign that buying U.S. debt increasingly seems like a bad bargain. Foreign demand for U.S. securities -- IOUs backed by the government -- fell by the largest amount on record in December. China led the way, reducing its holdings by $34.2 billion. Total foreign holdings of U.S. government debt fell by $53 billion, topping April's record drop of $44.5 billion.
If China has doubts, there's trouble ahead for the U.S. economy. When debt gets out of control, creditors get nervous and borrowers go begging. Cash-starved countries must raise interest rates to attract the financial markets. That raises the specter of inflation, reducing living standards and ultimately inflicting ruin.
Ordinarily, one lender's caution wouldn't be a problem, but ever since the fall of 2008, China has held the top spot among foreign countries with U.S. debt. Its willingness to buy U.S. notes makes it possible for the United States to finance chronic deficits by borrowing money at low interest rates during a rough period.
Trouble is, current deficit projections extend to the horizon and lenders know that endless deficits tend to cheapen the currency -- and thus the value of their holdings. When China sees the federal government lacking the will to deal with the problem, it has reason to worry.
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