College's Stake in China May Backfire

Colleges have a lot to lose if China's economy keeps declining and with its wealth. This is because China's wealth is the source of much college tuition both directly and indirectly. And one key source of wealth--China's official foreign reserves, has fallen more than 20% from $4 trillion in Aug 2014 to $3.2 trillion in January 2016. And it is still falling. In fact, China is in the middle of the biggest currency run in history. They're losing $100 billion a month.

Colleges may end up feeling like the panhandler who upon learning that his best tipper has gone bankrupt shouts out, "just because you're in trouble, I have to suffer!?!"

Unlike in the US, there are capital controls in China. Any Chinese who need dollars must go to a bank and exchange enough local currency to receive the amount of dollars to purchase something in the States from a home to the college tuition of their children. But with the fall in reserves, banks are only allowed to exchange a restricted amount each month, usually less than what their customers want.

The direct effect of this fall might be a reversal in the surge of Chinese international students coming to study in United States. The number of Chinese students increased fivefold in the last ten years: currently 31% of all international students are from China (304,040 students). They represent the largest group of international students. As foreigners, they must pay full tuitions without discount. Thus, if the headline tuition is $60,000, they must pay it, which helps subsidize the rest of the class. Obviously colleges have developed a love affair with Chinese students. It is estimated that tuition revenue from Chinese students amounts to about $8.3 billion. This is a large sum that won't go unnoticed.

There is, however, an indirect but potentially much more serious effect from the fall in Chinese reserves most of which are held in US treasury notes. The US has student debt outstanding of close to $1.3 trillion. In order to lend such large sums to students, the government mainly borrows from China through issuing treasury notes. But this works only if China keeps holding these notes and doesn't ask for its money back.

Were they to do so the US would have to find another lender, no doubt at higher interest rates. This threatens to further raise attention on student debt and even awaken the tax payer to the increasing risks of this debt. Currently, only 37% of borrowers are actually paying down their student debt. A sharp decline in Chinese purchase of US treasury bonds would threaten not only the rollover of current student loans (there is a mismatch between twenty year student loans and shorter dated US treasuries held by the Chinese requiring constant rollovers) but also the growth of the student loan program as resources dry up. It is of course true that bond holders risk is tied directly to the US government and not to the students. But risk policy requires that bond holders have a second source of repayment. Certainly students with their high default rates would not meet the standards of being a reliable second source of repayment.

Colleges are left praying for an improvement in the Chinese economy and no one has control over their prayers being answered.