China’s U.S. treasuries shift

China has steadily accumulated U.S. treasury securities over the last few decades and owes about $760 billion in treasuries, roughly 10% of the U.S. national debt. What if China would dump these treasuries in retaliation of tariff or trade wars? After all, there is in interest trend and the amount of U.S. treasuries China holds has been decreasing since 2017. Is China seeking to become less dependent on the U.S. and liberate its economy from the intertwined economic relationship with the U.S.? It might not be so easy, but rather a slow development in that direction.

China is primarily a manufacturing hub and an export-driven economy. Trade data from the U.S. Census Bureau shows that China has been running a big trade surplus with the U.S. since 1985. Chinese exporters receive U.S. dollars for their goods sold to the U.S., but they need renminbi (RMB or yuan) to pay their workers and store money locally. They sell the dollars they receive through exports to get RMB, which increases the USD supply and raises the demand for RMB.

China’s central bank, the People’s Bank of China (PBOC), actively intervenes to prevent this imbalance between the U.S. dollar and yuan in local markets. It buys the available excess U.S. dollars from the exporters and gives them the required yuan. The PBOC can print yuan as needed. Effectively, this intervention by the PBOC creates a scarcity of U.S. dollars, which keeps the USD rates higher. China hence accumulates USD as foreign exchange (forex) reserves. 

International trading which involves two currencies has a self-correcting mechanism as currencies appreciate and depreciate. This is the self-correcting mechanism that occurs in the international trade and forex markets regularly, with little or no intervention from any authority.

China’s strategy is to maintain export-led growth, which aids in generating jobs and enables it, through such continued growth, to keep its large population productively engaged. Since this strategy is dependent on exports, China requires RMB to continue to have a lower currency than the USD, and thus offer cheaper prices. If the PBOC stops interfering, the RMB would self-correct and appreciate, thus making Chinese exports costlier. It would lead to a major crisis of unemployment due to the loss of export business.

China wants to keep its goods competitive in the international markets, and that cannot happen if the RMB appreciates. It thus keeps the RMB artificially low compared to the USD using the mechanism that’s been described. However, this leads to a huge pileup of USD as forex reserves for China.

China has tight, state-dominated control over its economy and can manage inflation through other measures like subsidies and price controls. China’s central bank has approximately $3.2 trillion in total foreign exchange reserves. Like the U.S., it also exports to other regions like Europe. The euro forms the second biggest tranche of Chinese forex reserves. China needs to invest in such huge stockpiles to earn at least the risk-free rate. With trillions of U.S. dollars, China has found the U.S. treasury securities to offer the safest investment destination for Chinese forex reserves. With euro stockpiles, China can consider investing in European debt. Possibly, even U.S. dollar stockpiles can be invested to obtain comparatively better returns from euro debt.

China acknowledges that the stability and safety of investment take priority over everything else. Though the eurozone has been in existence for about two decades now, it remains unstable. Other asset classes like real estate, stocks, and other countries’ treasuries are far riskier compared to U.S. debt. Forex reserve money is not spare cash to be gambled away in risky securities for want of higher returns.

One more reason for China to continuously buy U.S. treasuries is the gigantic size of the U.S. trade deficit with China. The monthly deficit in 2024 was around $17 billion, and with that large amount of money involved, treasuries are probably the best available option for China. Buying U.S. treasuries enhances China’s money supply and creditworthiness. Selling or swapping such treasuries would reverse these advantages.

U.S. debt offers the safest haven for Chinese forex reserves, which effectively means that China offers loans to the U.S. so that the U.S. can keep buying the goods China produces.

Hence, as long as China continues to have an export-driven economy with a huge trade surplus with the U.S., it will keep piling up U.S. dollars and U.S. debt. Chinese loans to the U.S., through the purchase of U.S. debt, enable the U.S. to buy Chinese products.

It’s a win-win situation for both nations, with both benefiting mutually. China has a huge market for its products, and the U.S. benefits from the economic prices of Chinese goods. Beyond their well-known political rivalry, both nations are locked in a state of inter-dependency that will continue and from which both benefits.

An excess supply in China of U.S. dollars would lead to a decline in USD rates, making RMB valuations higher. It would increase the cost of Chinese products, making them lose their competitive price advantage.

If China stops buying U.S. treasuries or even starts dumping its U.S. forex reserves, its trade surplus would become a trade deficit, something which no export-oriented economy would want, as they would be worse off as a result. 

The ongoing worries about China’s holding of U.S. treasuries or the fear of Beijing dumping them must be seen in a long-term perspective, where China slowly decrease its dependency on the U.S. dollar and on export to the U.S.  

Although this ongoing activity has led to China becoming a creditor to the U.S., the situation for the U.S. may not be that bad. Considering the consequences that China would suffer from selling off its U.S. reserves, China will likely refrain from such actions as it would severely impact their export industry.  

China’s holdings of U.S. treasuries peaked between 2012 and 2013, with a value of over $1.3 trillion. Since then, its size has been slowly declining. It dipped below $1 trillion in mid-2022 for the first time since 2010. Today, it stands at $765 billion. China is currently the second-largest holder of U.S. treasuries, behind Japan, which holds around $1.19 trillion as of March 2024.

The most important reason for China buying U.S. bonds is that China receives a surplus of U.S. dollars due to the trade imbalance between the two countries, as China exports more to the U.S. than it imports. It is unlikely that China would sell its U.S. treasuries all at once because this would be economically painful for China and leave it holding dollars that it would need to spend or invest elsewhere. However, they are likely to continue reducing the debt as they are diversifying their economy and exports to other countries.

Geopolitical realities and economic dependencies often lead to interesting situations in the global arena. China’s continuous purchase of U.S. debt is one such interesting scenario. It continues to raise concerns about the U.S. becoming a net debtor nation, susceptible to the demands of a creditor nation.  

While the dollar is unlikely to be displaced as the dominant FX reserve currency any time soon, rising geopolitical tensions and the morphing of globalization into a world of polarized trading blocs could fray its preeminence at the edges.

Total global FX reserves at the end of March 2024 stood at $12.33 trillion, according to the International Monetary Fund’s COFER data, of which the currency composition of $11.45 trillion is reported in confidence to the IMF. The dollar’s share was 58.41%, the lowest on record. A desire on the part of many countries to distance themselves politically from the United States is emerging as one of the key drivers.

The share of gold in China’s FX reserves more than doubled to 4.3% last year from less than 2% in 2015. During the same period, China’s valuation-adjusted holdings of U.S. Treasury and agency bonds relative to total FX reserves fell to about 30% from 44%. It is the dollar, as the world’s dominant currency and symbol of American hard and soft power, that is likely to suffer as geopolitical tensions encourage countries to increase their holdings of gold and other currencies.

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