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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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Changing the Top Global Currency Means Changing the Patterns of Global Trade

• Michael Pettis

Giving up use of the U.S. dollar for global trade and reserve accumulation would be very difficult for U.S. adversaries and would require major economic adjustments, though it would be in the best long-term interests of the United States for the global use of the dollar to be more constrained.

• April 12, 2022

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But while there has been much debate over whether or not the world—or at least part of the world, including countries like China, Iran, Russia, and Venezuela—can live without the dollar, there has been much less attention on an equally important issue: what the trade impact would be of a world less tied to the U.S. dollar. The two issues cannot be separated. The issue of the dollar is part of the debate over global capital flows, but capital flows are just the obverse of trade and current account flows. Savings, after all, can only be expressed as the excess production of goods and services.

This essay makes three related points. First, it would be extremely difficult, if not impossible, for countries like China and Russia to upend the dominance of the U.S. dollar. Most sophisticated economic policy advisers in China and Russia know this, even if they have to express this knowledge cautiously.

Second, for the U.S. dollar to stop being the world’s dominant currency would mostly require specific action by U.S. policymakers to limit the ability of foreigners to use U.S. financial markets as the absorber of last resort of global savings imbalances. While most analysts still believe that the United States will never willingly take the necessary steps to end U.S. dollar dominance, there is a growing awareness of the costs of playing this role to the U.S. economy. Although any move to limit the international use of the dollar would be opposed by parts of Wall Street and the foreign affairs and military establishments, as the costs rise, this outcome will become increasingly likely.

And third, a global economy without the U.S. dollar—or some unlikely alternative—as the currency lingua franca also would be a global economy in which large, persistent trade and savings imbalances are impossible. This is probably a good thing for the global economy overall, but with so many major economies locked into structural domestic demand deficiencies, any policy that forces an elimination or sharp reduction of global trade imbalances also would force deep institutional changes in the global economy—changes which also would likely be politically disruptive for many countries. This is especially the case for countries whose economies have grown around persistent trade surpluses.
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It helps to consider the alternative assets surplus countries can accumulate to see why, in spite of decades of complaints in the international community, the U.S. dollar remains the dominant currency. In principle, surplus-running economies can accumulate small amounts of assets in other advanced economies, but with the exception of the European Union (EU) and perhaps Japan, none is big enough to balance more than a tiny share of the world’s accumulated trade surpluses. More importantly, Japan and the EU, along with most advanced, non-Anglophone economies, run persistent surpluses themselves, so they cannot accommodate the surpluses of countries like China and Russia. I will explain later why giving up these surpluses would be so difficult.

For the rest of this stimulating article:

https://carnegieendowment.org/chinafinancialmarkets/86878

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