There is a common knowledge that China is the largest holder of US national debt which basically is all outstanding US securities such as Bonds and Notes issued by the United States Treasury.
That common knowledge is not correct as the largest holder of US national debt is the United States Federal Reserve, not Communist China. Out of more than $16 trillion debt Federal Reserve holds $1.66 trillion while China holds only $1.276 trillion as of June 2103.
China is only the larget foreign holder of US National Debt not the largest holder of US National Debt. So why is the Federal Reserve the largest holder of US National Debt or the largest owner of US Treasury Securities? The answer is quite simple. United States is madly printing money left and right and recklessly spending it.
US Federal Reserve has been Printing Enormous Amount of Money
As a sovereign nation United States has the sovereign right to create or print money like any other sovereign nation. And that power to create or print money is vested by law in the Federal Reserve as the central bank of United States. Not in the hands of the government of the day.
But US government is near bankrupt by chronically spending more than their revenues and they need to borrow money. So the US government keeps on borrowing money just to survive as a nation. The government would love to print money, of course, but that power is not in the hands of the government. That power to print money is in the hands of Federal Reserve.
So US Government borrows money direct from the Federal Reserve by selling treasury securities direct to the Federal Reserve which prints (or creates) billions and billions of US$ to buy the treasury-securities worth billions and billions of US$. In the meantime the US national debt keeps on punching-up through the so-called mandatory debt ceilings.
But printing billions and billions of US$ (Federal Reserve has been printing at least $85 billion every month) should theoretically have a devastating effects on the US economy because of rapidly rising inflation. Like what did happen famously in prewar Germany and what has been happening now in the poorly-managed nations like Zimbabwe and Burma. That has not happened in United States just yet simply because of China, and why?
Is Communist China lending US money for Her Own Interests?
The result is that a sizeable part of US dollars American consumers spend on the Chinese-made products ended in the hands of Chinese government as the Chinese Communist dictatorship takes the US$ from its businesses and gives them equivalent Chinese Yuan printed in China.
Chinese Communists leave most of that US$ in US by lending back to US government by buying US treasury-issued securities exactly same as what US Federal Reserve is doing. So why is Chinese Communist doing that?
The Chinese have no choice but to lend to US government as that action has the direct result of keeping US$-Yuan exchange rate artificially low at about 7 Yuan a US$ at present. And that money injection by Chinese into American economy via the US Government also enables Americans to keep on buying Chinese goods and more.
Downward pressure on labor wages by massive number of Latino illegal immigrants (More than 20 million at latest official counts) also help in keeping the US inflation low and stable.
That low inflation basically enables the US Federal Reserve to print more money in turn to stimulate the sluggish US economy growing again.
(Following is excerpted from the Kimberly Amadeo’s article “Who Owns the U.S. National Debt?” from About.com Guide on September 5, 2013.)
The Fed's purchases stoked demand for Treasuries, which kept interest rates low. The Fed's been criticized for simply monetizing the debt. The Fed purchases Treasuries from its member banks, using credit it created out of thin air. This has the same effect as printing money. It keeps interest rates low, avoiding the high-interest rate penalty the Federal government would usually incur for excessive debt.
However, as the economy returns to normal, the Fed announced it will taper its $85 billion-a-month purchases of Treasuries. As a result, interest rates on the benchmark 10-year Treasury note rose from a 200-year low to around 2.9%.
China has increased its holdings from $1.147 trillion last year to $1.276 trillion this year. It's obviously not too concerned that the U.S. will default on its debt. China wants to keep the value of the dollar high.
This makes its own currency, the Yuan, relatively cheaper by comparison. That helps China's exports to the U.S. seem more affordable, which helps its economy grow. That's why, despite China's occasional threats to sell its holdings, it's happy to be America's biggest banker, and largest foreign owner of U.S. debt.”