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Investopedia

Why China Buys U.S. Debt With Treasury Bonds

By Shobhit Seth

Updated October 23, 2022

Reviewed by Julius Mansa

Fact checked by Yarilet Perez

China has steadily accumulated U.S. Treasury securities over the last few decades. In August 2022, the Asian nation owned $971.8 billion in Treasurys, roughly 13% of the U.S. national debt.1 U.S. debt to China comes mainly in the form of U.S. Treasury securities (bonds issued by the federal government).2

Some analysts and investors fear China could dump these Treasuries in retaliation and that this weaponization of its holdings would send interest rates higher, potentially hurting economic growth. This article discusses the business behind the continuous Chinese buying of U.S. debt.

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China’s Use of USD Reserves

China’s central bank had approximately $3.3 trillion in total foreign exchange reserves at the end of 2021.5 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.

However, 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 still remains unstable.6 It is not even certain whether the Eurozone (and Euro) will continue to exist in the mid-to-long term. An asset swap (U.S. debt to Euro debt) is thus not recommended, especially in cases where the other asset is considered riskier.

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.

Another option for China is to use the dollars elsewhere. For example, the dollars can be used to pay Middle East countries for oil supplies. However, those countries too will need to invest the dollars they receive. Effectively, owing to the acceptance of the dollar as the international trade currency, any dollar supply eventually resides in the forex reserve of a nation, or in the safest investment—U.S. Treasury securities.

U.S. Debt to China and the Trade Deficit

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 August 2022 was around $37 billion, and with that large amount of money involved, Treasuries are probably the best available option for China.3 Buying U.S. Treasuries enhances China’s money supply and creditworthiness. Selling or swapping such Treasuries would reverse these advantages.
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What Would Happen If China Sold All of Its Treasuries?

First, 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.

The most immediate effect would be an increase in interest rates on Treasuries, since selling so many at once would artificially depress their prices in the bond market – thus increasing their yields. If the Fed were not to react at all to such an event, it is estimated that it would increase long-term Treasury yields by 30 to 60 basis points.

For the whole article:

https://www.investopedia.com/contributors/53524/

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