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U.S. treasury securities: Why China keeps buying them?

Chinese around the globe were outraged by a comment by a boy on Jimmy Kimmel Live, in which he joked about killing Chinese people to help erase the U.S. debt. ABC swiftly apologized, saying the network “would never purposefully broadcast anything to upset the Chinese community, Asian community, anyone of Chinese descent or any community at large.”

According to the U.S. Treasury, China now owns 23% of the U.S.’s treasury securities. (Hong Kong is among the top ten holders, if we break down the “Caribbean Banking Centers” and “Oil Exports” into their constituent countries.) The U.S. was closed to default just two weeks ago, and its fiscal outlook doesn’t look that good either. According to conventional wisdom, a country can only lower its debt-to-GDP ratio by 1) growing out of debt; 2) inflating away its debt; 3) defaulting. With the U.S. economy still struggling to grow enough (growth rates average around 2% in recent quarters), and the inflation rate still hovers around lower-than-preferred level, defaulting seems to be a tempting choice.

So why would the Chinese want to hold the U.S. treasury securities anyway? According to Stephen Roach, a former Chairman of Morgan Stanley Asia, “China buys Treasuries because they suit its currency policy and the export-led growth that it has relied on over the past 33 years.” Or to be precise, he argues that China kept buying U.S. treasuries in order to keep its exchange rate low, which stimulates export.

China has recycled about 60% of these reserves back into dollar-denominated US government securities, because it wants to limit any appreciation of the renminbi against the world’s benchmark currency. If China bought fewer dollars, the renminbi’s exchange rate – up 35% against the dollar since mid-2005 – would strengthen more sharply than it already has, jeopardizing [competitiveness] and export-led growth.

Yet China is changing its development model from an export-led to a more consumption-led one…

China has made a conscious strategic decision to alter its growth strategy. Its 12th Five-Year Plan, enacted in March 2011, lays out a broad framework for a more balanced growth model that relies increasingly on domestic private consumption. These plans are about to be put into action.  An important meeting in November – the Third Plenum of the Central Committee of the 18th Chinese Communist Party Congress – will provide a major test of the new leadership team’s commitment to a detailed agenda of reforms and policies that will be required to achieve this shift.

… which suggests that China may not need to buy as much U.S. treasuries as before.

Rebalancing is China’s only option. Several internal factors – excess resource consumption, environmental degradation, and mounting income inequalities – are calling the old model into question, while a broad constellation of US-centric external forces also attests to the urgent need for realignment.

With rebalancing will come a decline in China’s surplus saving, much slower accumulation of foreign-exchange reserves, and a concomitant reduction in its seemingly voracious demand for dollar-denominated assets. Curtailing purchases of US Treasuries is a perfectly logical outgrowth of this process. Long dependent on China to finesse its fiscal problems, America may now have to pay a much steeper price to secure external capital.

Roach forecasts that “[t]he days of its open-ended buying of Treasuries will soon come to an end.” That seems to be a logical conclusion. Furthermore, China always aspires to make the renminbi a global reserve currency one day, which can rival with the U.S. dollar and the euro. To do so China would have to “vote by its feet” by divesting its U.S. dollar portfolio. It is only a matter a time that China will stop supplying the cheap capital to the west, and the bigger question, when the time comes, would be: how the global economy can adjust to the new landscape?

(I calculated China’s holding of U.S. treasury securities to be 23% of the total outstanding securities. My source is here. It is more than double than the 11% figure mentioned by Roach in his article. One reason to reconcile the difference is that the 11% figure is “China’s share of America’s publicly-held debt”, while mine is China’s share of treasury securities. I still haven’t figured out what is the difference between “publicly-held debt” and “treasury securities”, however.)

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