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This is the second part of an examination regarding the propensity to save in the Chinese economy; the first part was published yesterday. It’s always a good idea to check our own understanding of concepts before we take them to pieces for others. So my (somewhat rhetorical) question to you is this; “What happens to your money when you put it in the bank and save it?”

Banks and financial institutions make gun runners out of all of us. Depressing thought isn't it?

And here’s the thing; you don’t know and nor do I. We can all spout some vague mantra about our cash being invested with lots of other cash in things that we don’t know about, or it being lent out to other people to accrue interest, but not one of us can say precisely where our money goes in the banking system – and nor can any of us really explain how it’s out there doing work, when it’s shown to be in our accounts all at the same time too.

This is a good thing for banks everywhere, if your customers are willing to give you money and let you use it in any way you want – as long as you keep showing them a piece of paper or a screen, that says; “All your money is still here!” you have a license to steal. It means that you can use people’s money for things that they would never condone themselves; like investing in weapons that will kill thousands of children in war zones, or tobacco products which will certainly kill some of your friends and neighbors, heck it can even be used to hire people to throw your grandparents out of their home if they miss a payment on the mortgage – and you won’t know about it.

This series is about the Chinese economy - but for Americans who would like a useful look at their own debt, this graph is a good one. It's debt expressed as % of GDP - it shows two things, one; it's republicans that increase debt (not democrats) and two; the current level of debt has been seen before and your nation did just fine afterwards too. (Source: The Big Picture)

And in general terms this is exactly what happens, all around the world. So when you hear that China owns $2 trillion of US debt, this isn’t exactly true. What is true is that the Chinese banking system, has lent $2 trillion of other people’s money (some of whom may not even be Chinese – after all there are plenty of foreigners and foreign companies in China) to the US in exchange for a tiny rate of interest.

It sounds impressive too doesn’t it? But remember what I said about big numbers being misleading, it’s true here as well. The US national debt is closing in on $16 trillion dollars. So China actually owns about 12-14% of this debt – that’s not “China owns the USA” it’s “China owns 12-14% of a promise by the USA to pay back $16 trillion at some point in the future.”

That promise is not all it’s cracked up to be – historically purchasers of American treasuries, roll them over after they’re finished – that means they only take the interest and drop the principal sum straight back into the system again.  This is because American T-bills are considered to be safe financial instruments with a guaranteed return and many financial institutions like a large chunk of their investments to be 100% (or as close as possible) guaranteed.

So that means something more like – America promises to pay China, around $40 billion (which is about 2% of $2 trillion) over the next 10 years or so, which works out at $4 billion a year. And while that number is still a “big number” – we know that $4 billion doesn’t go very far in terms of government spending and is hardly a reason to start crying into our Chinese made cereal bowls each morning.

Who owns the rest of the debt? Well that would be the American people – the same people who are being condemned for never saving and living on the never, never beyond their paltry means. It’s their money, in their own banks, pension funds, etc. that’s been used to buy up most of the rest of the debt. So you can sleep safely knowing that China’s not bought the country out from under you just yet.

It's partly interest payments on the T-bills that American institutions own - that keeps American pensioners collecting a pension. So that debt's not all bad is it?

This is a single glance at an aspect of the power of Chinese savings outside of China, and it’s not a very good deal for the Chinese saver – American T-bills pay low rates of interest (very low) because they’re such safe instruments. There is a flip side of this investment for China which might make this a much better deal for the Chinese than the Americans, and we’ll come to this later in the series when we examine – the valuation of the RMB.

Tomorrow we’ll stick with savings and ask the key question that seems to be forgotten when people talk about China’s economy. “Alright, if Americans own most of their national debt, is the same true for Chinese people when it comes to China’s national debt? And if so, what does that mean in the near future?”