Is China really dumping US bonds?

China is often seen as the biggest creditor of the United States, holding more than $1 trillion worth of US government bonds. But recent reports have suggested that China is reducing its exposure to US debt, sparking fears of a potential bond market crash. However, a closer look at the data reveals a more nuanced picture of China’s role in the US bond market.

China’s hidden holdings

According to the US Treasury Department, China’s official holdings of US Treasurys fell by $106 billion between June 2020 and June 2021, reaching $1.06 trillion. This was the lowest level since 2017, and marked a 9% decline from the peak of $1.17 trillion in 2019.

However, these figures do not capture the full extent of China’s investment in US debt. Brad Setser, a former Treasury official and a senior fellow at the Council on Foreign Relations, argues that China has been buying US debt in other forms, such as agency bonds issued by Fannie Mae and Freddie Mac, which are not included in the official data. Setser estimates that China’s total holdings of US bonds, including agency bonds, are around $1.4 trillion, and that China has actually increased its purchases of US debt by $100 billion in the past year. He bases his analysis on the balance of payments data from China and Hong Kong, which show a large increase in China’s foreign exchange reserves and net foreign assets.

Reasons for selling Treasurys

If China is not dumping US bonds, then why did it sell some of its Treasurys in the past year? One possible reason is that China needed to support its currency, the yuan, which has depreciated against the dollar by about 10% since 2018. By selling Treasurys and buying yuan, China can prevent its currency from falling too much, which could hurt its exports and economic growth.

Another possible reason is that China is seeking to diversify its foreign exchange reserves away from dollar assets, amid rising geopolitical tensions with the US. China may be looking to invest in other currencies, such as the euro, the yen, or the renminbi, or in other assets, such as gold, commodities, or equities. This could reduce China’s dependence on the US financial system and its vulnerability to US sanctions or trade wars.

Impact on bond market

The US bond market has witnessed a sharp sell-off in recent weeks, pushing the 10-year Treasury yield to its highest level since 2007, at around 3.5%. Some analysts have blamed China’s sales of Treasurys for the bond rout, arguing that China’s reduced demand for US debt could drive up interest rates and hurt the US economy.

However, Setser disagrees with this view. He says that China’s sales of Treasurys are too small to have a significant impact on the bond market, and that other factors are more likely to be driving the bond market. These factors include strong US economic data, which have boosted expectations of higher inflation and interest rates, as well as the Federal Reserve’s tapering of its bond-buying program, which has reduced the supply of money in the market. Setser also points out that China’s sales of Treasurys have been offset by other buyers, such as Japan, the UK, and domestic investors, who have increased their holdings of US debt. He says that the US bond market is still very liquid and attractive to global investors, and that China’s role in the market is often exaggerated.

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Source: Yahoo

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