China Is Dumping U.S. Bonds

How Will This International Economic Move Affect U.S. Interest Rates?

China Is Dumping U.S. Bonds
September 4, 2014

China is still the largest holder of U.S. debt, but that may not be true for long. Japan, the largest U.S. debt holder prior to 2008 — and the only other nation to currently hold more than $1 trillion in U.S. public debt — has been closing the gap over the past year.

The last foreign holdings estimate from the Treasury Department shows China with $1.268 trillion in holdings versus the $1.219 trillion held by Japan. China’s total foreign currency reserves are already the largest in the world, valued at almost $4 trillion.

China has shed holdings in U.S. bonds since hitting a peak of $1.317 trillion in November 2013 and announcing it would no longer buy U.S. treasuries. Some analysts are concerned that a larger dump of U.S. treasuries is likely in order to produce a rise in U.S. interest rates and a stronger dollar.

In this line of reasoning, outlined by Lombard Street Research, China needs to continue weakening the yuan to revive their slowing economy. Strengthening the dollar relative to the yuan could achieve that purpose.

Since June 2010, when China allowed the yuan to appreciate again from its set 6.83 yuan to the dollar, the yuan appreciated at a relatively steady rate to a peak of 6.04 yuan to the dollar in January 2014. The sale in January 2014 of $48 billion in U.S. bonds dropped the yuan to around 6.26 before the appreciation resumed. It is now at 6.15 with a steadily appreciating trend.

The yuan is notoriously difficult to evaluate because of China’s policies of pegging the yuan to the dollar and limiting currency appreciation to a small range. The vast majority of analysts believe the yuan is undervalued; the International Monetary Fund estimates around a 5-10% undervaluation. Lombard, on the other hand, believes the yuan is actually 15-25% overvalued.

Regardless of who is correct, the Chinese government seems to be determined to reverse their currency appreciation. With the limitations on Chinese investment, the market cannot naturally resolve capital flows, leaving the Chinese government little choice but to wield the power of its currency. China is trying to keep their goods economical and their export dollars at a premium, which should in turn spur further growth and keep employment relatively high.

Chris W. Street on suggests the effect of the Chinese selling their U.S. Bond holdings would be to raise 10-year Treasury yields by a maximum of ½% and to bump up interest rates in the U.S. by approximately 1% – if the sale were done smoothly. Economic recovery in the U.S. would be harmed, but not be reversed.

Others see little reason for concern. Kenneth Rapoza correctly points out in Forbes that the declines to date are relatively small, and that for the past two years, the dollar has been strengthening against foreign currencies.

Lombard’s projection is that the Eurozone would be harmed more than the U.S., thanks to a double whammy of a higher U.S. bond yield and a devaluation of the yuan. An unfavorable trade imbalance is likely to follow, exacerbating European economic difficulties. Further, according to Diana Choyleva of Lombard in a contribution to the Financial Times, the end result of such upheaval in the Eurozone could send investors toward the relative safety of U.S. bonds – blunting the effect of China’s actions.

In summary, the Chinese are likely to continue to dump bonds, but in a relatively measured way –the effects on the U.S. may be unpleasant but they are not likely to be catastrophic.

  Conversation   |   0 Comments

Add a Comment

By submitting you agree to our Terms of Service
$commenter.renderDisplayableName() | 06.17.21 @ 06:22