Almost as soon as China became a major buyer of U.S. Treasury holdings nearly two decades ago, American policymakers and pundits began fretting that they would one day sell them off rapidly — wreaking havoc on the U.S. economy in the process.
The past few months have been no exception. Headlines have proclaimed that China is slashing its stock of U.S. Treasurys after data came out showing that it fell to $970 billion in July from $1.06 trillion the year before, the first time in over a decade that figure has fallen below $1 trillion.
A closer look at the data, though, shows both that the recent reduction in China’s U.S. Treasury holdings is pretty modest, and that it remains a major foreign owner, with only Japan ahead. China has also been increasing its purchases of bonds issued by other U.S. government-sponsored institutions such as Fannie Mae or Freddie Mac, usually known as agency debt.
Of course, China could continue to sell down its Treasury stockpile, due to the combination of pressure on the renminbi and its desire to reduce its reliance on the dollar. But the fact that China’s holdings have stayed relatively steady thus far underscores the interconnected nature of the American and Chinese economies, and the challenge for China as it attempts to insulate itself from the U.S. financial system.
“You often see headlines, [that China’s] Treasury holdings are up or down,” says David Dollar, a senior fellow at the Brookings Institution and former Treasury official. But, he notes, “It has been pretty stable. The shifts are often small and hard to interpret. You hear lots of talk from Chinese officials about dollar dominance, but you don’t actually see a change in their behavior. There is not much you can do with trillions of dollars besides putting it in dollar [assets].”
The most important, but ultimately boring, trend is that for the past five [or] six years, China’s holdings of Treasurys and agencies have been relatively stable, with a modest shift towards agencies.
Brad Setser, a senior fellow at the Council on Foreign Relations
China’s move into agency debt — likely driven by the higher yields they usually offer — is just one of many factors that make it hard to interpret the monthly so-called TIC [Treasury International Capital] data, which breaks down U.S. Treasury ownership by country. Chinese holders of U.S. government debt have for many years made some of their purchases via financial centers in locations such as the U.K., Belgium and the Cayman Islands, making it difficult to calculate total Chinese ownership.
“Most observers look at the Treasurys portfolio, and forget about the agencies,” says Brad Setser, a senior fellow at the Council on Foreign Relations who previously worked in the Office of the U.S. Trade Representative. “The most important, but ultimately boring, trend is that for the past five [or] six years, China’s holdings of Treasurys and agencies have been relatively stable, with a modest shift towards agencies.”
China’s holdings of U.S. government debt first started to pile up in the early part of this century, around the time the country’s exports started to surge. Chinese manufacturers would exchange the dollars they received for goods into renminbi, to pay their costs and workers’ salaries. To prevent the renminbi’s value from rising too fast as a result, China’s central bank would step in to buy up dollars, reinvesting them in the safest asset available — U.S. Treasurys and other government-linked bonds.
That system helped to keep the renminbi’s value low, allowing Chinese goods to stay relatively cheap and fueling China’s breakneck growth. By 2008, China had become the largest holder of U.S. Treasurys, with its holdings peaking at around $1.3 trillion in 2013.
Since then, Chinese holdings as a percentage of outstanding U.S. debt have decreased, largely due to the U.S. government issuing more bonds — but the value of China’s holdings has remained relatively stable for the last several years slightly above the $1 trillion mark.
U.S. politicians have periodically cited China’s piling up of treasurys as a potential vulnerability. Asked in 2007 why the U.S. cannot ‘get tough’ on China, then presidential hopeful Hillary Clinton responded by asking rhetorically, “How do you get tough on your banker?”
The recent worsening of relations between the U.S. and China has heightened concerns that Beijing might sell down its U.S. government debt to weaken the American economy. Others have cited China’s Treasury holdings as a weapon that could limit any U.S. response to a future Chinese invasion of Taiwan.
But most experts agree that any such move by China’s central bank, often called the “nuclear option,” would ultimately hurt its own economy more than the U.S., and that it would be relatively easy for the U.S. government to find other buyers for its debt, starting with its own Federal Reserve.
“It has always been overstated,” says Logan Wright, a partner at Rhodium Group, referring to the theory that China could weaponize its holdings. “It would never make that much a difference. The Fed has already demonstrated that they can step in and manage it.”
Russia’s war on Ukraine and the financial sanctions the West imposed in response have caused Beijing to intensify its efforts to decouple from the dollar and the dollar-led global financial system.
Diana Choyleva, chief economist at Enodo Economics
What is more likely in the near future is that China’s central bank will continue to steadily sell its treasury holdings in order to prop up the renminbi, which recently hit a record low against the greenback, driven by a combination of the Federal Reserve’s recent interest rate hikes alongside the slowing Chinese economy.
“The Chinese central bank is sending clear signals it wants to slow the renminbi’s decline against the dollar,” says Mark Sobel, a longtime Treasury official who is now the U.S. chairman of the Official Monetary and Financial Institutions Forum. Last month, the People’s Bank of China cut the amount of foreign exchange reserves that state-owned banks must hold, a signal to market participants that it doesn’t want the renminbi to slide too far, too fast.
The U.S. government’s unprecedented financial actions against Russia after the invasion of Ukraine has also emphasized the risk to China of relying on the dollar. The U.S. joined other major countries in freezing Russia’s central bank assets, and cut the country off from SWIFT, the Gmail of the global banking system. If China were ever to face similar sanctions, following an invasion of Taiwan, for example, the U.S. government could freeze its holdings of Treasury debt.
“Russia’s war on Ukraine and the financial sanctions the West imposed in response have caused Beijing to intensify its efforts to decouple from the dollar and the dollar-led global financial system,” says Diana Choyleva, chief economist at Enodo Economics. “But this is a difficult transformation to pull off.”
Katrina Northrop is a journalist based in Washington D.C. Her work has been published in The New York Times, The Atlantic, The Providence Journal, and SupChina. @NorthropKatrina