Richard Lee

Since the beginning of the year, Chinese officials have been re-allocating their trillion-dollar reserves into assets of other foreign nations. For the first six months of the year, China invested $3.4 billion in Korean securities and another $20.1 billion in Japanese government bonds. At the same time, it has slowly and steadily reduced its exposure to US Treasuries.

Could this be the start of a shift in China’s love affair with US bonds? And if so, what’s to stop the Chinese government from a full exodus of the market? Those questions have sparked numerous pockets of speculation for US bond markets…and are provoking a lot of fear. Is there a reason to worry?

Let’s find out by taking a look behind the hype.

There is no question the Chinese are selling US bonds. On August 16, the US Treasury announced that China had sold US bonds for the second consecutive month – dumping approximately $24 billion worth. This was on top of $34.2 billion in US fixed-income securities the Chinese officially unloaded in February. Combined, both sales represent a 2.3% drop in holdings from January to June – with total US bond holdings declining by 5% since the beginning of the year.

China’s disinterest in US securities has also narrowed its lead over Japan as the largest holder of US debt. Previously holding an average $100 billion a month differential over Japanese coffers, Chinese holdings were now only about $40 billion more in the last month.

But don’t declare a bond apocalypse just yet.

For one thing, China’s $58 billion US bond sale represents only a fraction of its holdings. And Chinese investments in US government bonds only make up approximately 7% of the total amount of US bills and bonds that Beijing owns. All told, China holds about $844 billion in US treasury bills and bonds.

The sale looks even less significant when you consider Beijing’s foreign security portfolio as a whole. With almost $2.5 trillion in foreign securities and other investments, China’s sales only constitute about 2.3% of overall holdings.

It’s also a mistake to assume that China is selling because it’s wary of US investments. There are a plethora of possible reasons the country is selling now – a shift in short-term strategy, hedging or portfolio reallocation, etc… Given the relatively small percentages of overall holdings these sales constitute, it’s hard to see any real or convincing shift in Chinese sentiment towards US securities in the long term.

As everybody knows, Beijing does what is good for China. This means ensuring that the nation’s financial future is not placed in any immediate danger (especially its state-run portfolio). If China were indeed looking to sell US Treasuries en masse, they wouldn’t do it in a public manner. Chinese officials know that the world is watching every market announcement. The sentiment could not be more pertinent when applied to China and its massive reserve holdings.

If speculation evolved into fact, selloffs in major US Treasury markets would not only hurt existing Chinese positions, but it also would leave the administration with considerable losses. The predicament would have lasting and massive implications on China’s regime and the world economy. Considerable portfolio losses would plunge the economy into a compromised situation, since the government would have little in the way of cash and assets. So there is absolutely no incentive for Chinese officials to announce – subtly or outright – their intentions to rid themselves completely of US Treasury securities.

So what does it tell us? The recent transactions simply mean that Chinese officials are just like every other investor. They want meaningful rates of return, but they also require diversification. This is particularly important for China’s dollar-based investments. Although we don’t know exactly what’s in China’s portfolio, estimates place the overall investment book at 60-65% US assets. And since US dollar-denominated assets constitute a large portion of the Chinese portfolio, it was only a matter of time till Beijing authorities opted for a relatively small re-allocation.

In other words, it’s a bit premature to be calling it the end of China’s investment interests in the US Treasury bonds. Remember, the communist regime still maintains a relatively fixed band on its own currency. And in order to maintain that band, Chinese officials need US bonds. The Chinese government sells the yuan (or renminbi) when buying US Treasuries (or US dollars) to keep the exchange rate stable. This necessity not only ensures China’s interest in retaining current dollar holdings, but also temporarily guarantees no decisions towards any massive shift in current positioning.

Richard Lee
for The Daily Reckoning

Richard Lee

Richard Lee has been involved in the global financial markets for nearly 12 years, amassing experience with different instruments including equities, options and futures while specializing in foreign exchange.  Before joining Agora Financial, Richard had held proprietary trading positions in various funds, with his current position being in an international Global Macro Fund.  Additionally, Rich was a senior FX strategist for one of the largest retail brokers, helping to develop the firm's research web portal.

  • tony bonn

    the only plausible part of the article was the relation of the need of the chinese to manipulate currency via treasury purchases….

    otherwise the long term goal of the chinese is to weaken the dollar in a bid to replace it as a reserve currency…which is ok with me….the usa needs to give up its imperial ways.

    the chinese just aren’t at a place where they can do that. for all of its size, china is not yet a financial heavy enough weight..it’s day is coming though…

  • LeadZep

    It is like a Long Game of Monopoly, in which the Players are the Governments of the World.

    To put the rest of the Players Out of the Game, Ends the Game.

    It will be a Long Drawn Out Torture of the Peasants… Provide Some Hope, just enough to keep things Moving.

  • SImon

    I aggree with China’s stand. USA should stop consuming more than it gets

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