Will China pare down its US Treasury holdings anytime soon?

Bloomberg News Online reported on December 16, 2013 that the latest data released by the United States Treasury Department indicated that overall treasury holdings held by China increased by USD 10.7 billion, or a 0.8 percent, to USD 1.304 trillion. In addition, China held a record of USD 1.314 trillion in July 2011; Total foreign holdings of US Treasuries increased USD 600.0 million, or 0.01 percent in October 2013 to USD 5.65 trillion. The increase in US treasury holdings held by China has been debated by many US lawmakers in the past, citing the potential destabilising factor that might result, should the Chinese government decides to pare down its stake.

The question is why in the first place, China has been accumulating so much of US debt holdings, and was it for receiving a reasonably safe, guaranteed, steady returns/income, or is it a strategic move in case Sino-US diplomatic relationships turn sour? These questions are quite significant and do deserve some form of an analysis. The reasons are plenty, but if one were to look at the historical rivalry between both super powers, one might realise that the former is a naïve assumption because China owns approximately USD 1.3 to USD 1.6 trillion of foreign exchange reserves which is already sufficient to cushion any potential credit events, and it is perhaps not seen as a wise investment decision in putting its cash into such low-yielding foreign security such as the US Treasuries despite the risk-free status it enjoys globally. The latter motive on making a strategic case for investing in US Treasuries could be a possible and even an actual intention by the Chinese government to gain global influence and standing over the United States.

The Chinese government has always been a long-standing foreign lender, especially with its relatively large stake in US treasury holdings. However, with the growth outlook seen in China that has already being watered down in 2014 to an expected lower end of 7.0 percent annualised growth, as compared to previous years of approximately 9.0 to 10.0 percent annualised growth, the Chinese government has taken various steps to ensure that the Chinese Yuan continues to maintain at very tight ranges of approximately 6.1108 per US dollar as of Monday, December 16, 2013. As of early Asian trading hours on December 18, 2013, the spot exchange rate for the CNY: USD average quote of 6.0695 – 6.0715 (bid/ask) ranges. The Chinese government adopts a daily fixing of its currency rates as part of its efforts to manage tight ranges for the Chinese Yuan currency in order to strengthen the country’s export competitiveness.

However, the latest report from the US Treasury Department seems to paint quite a deep contrast on some of the recent remarks made by some of the Chinese government officials regarding its foreign currency holdings, including US treasuries. Readers might have recalled one of the People’s Bank of China (PBOC) officials by the name of Deputy Governor Yin Gang who was recently quoted in November 2013 that the country was no longer interested in increasing its foreign currency reserve holdings. Another PBOC official, Governor Zhou Xiaochuan wrote an article meant for November 2013 Third Plenary Session, which outlined its latest monetary policy initiatives of ending its normal intervention in the currency market and broaden the Chinese Yuan’s daily limit. PBOC’s holdings are considered to be one of the largest in decades, and have surged USD 166.0 billion during 3Q13 to a record of USD 3.66 trillion. Although the data is considered as historical, and might not be reflective of what the country might do next, readers might probably want to take note that the data was backdated to October 2013, which saw the first US federal government shutdown for decades and the uncertainties over raising the debt ceiling forms much of the political wrangling in Washington D.C.. Although such conditions might result in rapid capital outflows due to uncertainties over the compromising of any form of an agreement by the US lawmakers, it seemed that the Chinese government continued with is monetary policy initiatives, choosing to purchase more US treasuries despite the budget impasse happening in the US capital then.

What do the latest monetary policy statements and actions of both the PBOC Deputy and its Governor suggest about how the Chinese government plans to exit itself gradually from US Treasuries? It could be a careful weighing of pros and cons in limiting the Chinese government’s exposure to US Treasuries. However, for strategic reasons and perhaps a diplomatic tool used against the US government and other Western powers, the Chinese government holdings of US Treasuries might be seen as threatening. This example is clearly shown in the height of the Global Financial Meltdown in 2008-09 when prices of US Treasuries soared, yields came down, and the Chinese government reacted in a similar panic mode, which led them to increase their holdings of US Treasuries. Fast forward to 2013 and 2014, the Chinese government continues to accumulate more US Treasury holdings for the purposes of foreign exchange market intervention to fix the value of the Chinese Yuan, and the US Dollar is showing signs of recovery as a result of the recent improvement in economic conditions in the country. But, for how long will the Chinese government continue maintaining its foreign bond buying programme remains unknown? The Chinese government has also came out repeatedly to criticise US lawmakers for failing to compromise during the October 2013 US government shutdown, and as one of the largest creditors of the United States, it is not quite surprising to witness such reactions coming from the Chinese side, as they want to seek assurance that the US debt obligations get fulfilled, as part of the debt covenant agreement just by owning US Treasury holdings.

Going forward, the question of whether there will be a continuation of a pent-up demand for US Treasuries will largely dependent on how the US lawmakers intend to cooperate with each other , and find a common ground in future policy debates. The debates over future budget talks must take into account creditors’ interests, despite the various challenges in seeking compromises from other parties. It also represents a formidable force carried out by China in terms of how will they be exerting the Chinese influence across the Asia-Pacific region during the absence of the United States. These questions do point the urgent need for lawmakers to come into an agreement soon in any budget negotiations, as creditors such as China will eventually demand credit protection if things run out on hand, and could turn out to be a costly affair with the acceleration of monetary outflows, resulting in sharp volatilities across all asset classes. The United States government needs to weigh in on these issues before undertaking any policy moves that might not even solve the ongoing government deficits, and could antagonise creditors such as China, if they resort to treating creditors in a draconian manner. However, going by past records, and unlike other rogue nations, the US government does have a consistent record of honouring its debt obligations faithfully and diligently.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc