Mainland China reduced its holdings of United States debt by US$23 billion to US$980.8 billion in May from April, the first time the total dropped below the US$1 trillion mark in 12 years, the US Treasury Department said on July 18. China’s US debt holdings have dropped for six consecutive months.
Japan, the current largest holder, and more than 10 other holders of US Treasuries also disposed of their US debts to some degree.
What caused the US debt to fall out of favor?
Wang Yongzhong, director and researcher of the International Commodities Research Office of the Institute of World Economics and Politics of the Chinese Academy of Social Sciences, told Guancha.com that the United States’ sanctions and freezing of assets of countries such as Russia and Afghanistan had caused concern about the safety of the US debt investments.
Another reason, he said, was that high inflation in the US has also led to “a reduction in the US Treasury yield.”
“US Treasuries themselves are risk assets, so our holdings are also declining,” said Wang.
Wang said it was an overall trend that China would have a more flexible and diversified allocation of its overseas assets. However, he added that the US dollar remained a very important overseas asset for China.
“Although the purchasing power of the US dollar has fallen sharply, it is still a ‘strong currency,’” he said. “Returns from other bonds, such as those in Europe and Japan bonds, are less than those of the US bonds.”
On July 18, the US Treasury Department released its Treasury International Capital (TIC) report for May 2022. According to the report, mainland China’s holdings of US debt fell by US$22.6 billion to US$980.8 billion at the end of May from a month earlier, the sixth consecutive monthly decline and the lowest level since May 2010.
Japan, an economic ally of the US and the largest “creditor” of the US, also reduced its holdings of US debt. In May, its holdings of the US debt fell to US$1.212 trillion, the lowest since January 2020.
At the same time, more than 10 major holders, including Saudi Arabia, India, and Australia, sold US bonds to some degree. However, the United Kingdom, the third largest holder of US debt, still increased its holdings by US$21.3 billion to US$634 billion in May from April.
For the same period, overseas holders had sold a net US$8.3 billion in long-term bonds and a net US$22.8 billion in short-term bonds. Overall, foreign holdings of US debt fell from US$7.455 trillion in April to US$7.421 trillion in May, the lowest level since May 2021.
The US Treasury Department will announce the quantity of US debt assets held by overseas economies on August 15.
Why did the major overseas holders dispose of the US bonds simultaneously?
US sanctions arouse safety concerns
Wang said the US sanctions against Russia, Afghanistan and other countries had reduced the stability of US debt. He said concern about the safety of US debt was one of the reasons for the “reduction of China’s holdings of US debt.” He added:
In the past, global investors, including China, regarded US debt as a “safe and high-quality asset.” But after the outbreak of the Russian-Ukrainian conflict in February this year, the US and some European countries froze Russia’s national assets. The US also froze the overseas assets (about US$9.5 billion) of the former Afghan government, and misused those funds (more than US$3 billion without authorization to compensate the families of the victims of the 9/11 attack). Due to the United States’ behavior, China’s central bank and investors, and even the whole world, have raised concerns about the safety of US bond investment. If there is a conflict between China and the US in the future, will the US also freeze the US debt we are holding? This is a factor for China to cut its US debt holdings.
In a TV program called “China Now” on July 11, Huang Renwei, executive vice director of Fudan University’s Institute of Belt & Road and Global Governance, said people lost confidence in depositing their fortunes in the US after the US froze or confiscated Russian assets and forbade Russia to use SWIFT.
Huang said that, in order to avoid the effects of future US sanctions, many countries, whether they are US allies or not, had to reduce their US dollar reserves and also their reliance on SWIFT.
He said such a trend would cause major damage to the dollar hegemony system. This damage might not be obvious in the short term, he said, but the dollar reserve and SWIFT could be in danger of collapsing if everyone reduced the dollar reserve year after year and diversified to use other international payment systems.
The latest data from the US Treasury Department showed that Russia’s holdings of US debt amounted to only US$2 billion. In 2010, Russia still held US$176.3 billion of US debt and was one of the major overseas creditors of the US. The figure fell to US$131.8 billion in 2014 and US$14.9 billion in 2018. After that, Russia continued to sell US debt until the amount shrank to US$2 billion, or almost none.
High inflation in the US hurts treasury yields
Wang said another major reason for the US debt to be “falling out of favor” was its squeezed returns.
“Inflation in the US has reached 8-9%, causing the prices of the US bonds to fall sharply. Although the dollar has appreciated against other currencies, it has declined seriously in terms of its actual purchasing power. So the return on US debt investment is definitely negative. China will surely take this investment income issue into consideration,” Wang said.
Public information showed that Fed officials had raised interest rates in the past three meetings to curb the rise in US inflation.
The first rate hike was in March, raising interest rates by 25 basis points. This was followed by a 50 basis-point rate hike in May. Last month, the Fed announced a 75 basis-point rate hike, the largest increase in nearly 30 years.
According to data released by the US Department of Labor on July 13, the US consumer price index (CPI) rose 1.3% in June from May, or 9.1% year-on-year, the highest growth since November 1981.
Fed officials said on July 15 that they might further raise interest rates by 75 basis points in the meeting on July 26-27.
After the troubling inflation figure was announced on July 13, some market people expected that the Fed would consider raising the inflation rate by one percentage point.
According to a report by Bloomberg on July 14, economists at Citigroup expected the Fed would raise interest rates by 100 basis points.
The Wall Street Journal reported that Christopher Waller, a member of the Board of Governors of the Fed, said at a meeting in Victor, Idaho, on July 14 that “excessive rate hikes are not what we want.” He added that “a 75 basis point rate hike is already aggressive” and “you can’t say we did not fulfill our duty for not raising rates by 100 basis points.”
The Fed has not raised rates by a full 100 basis points since it began using the federal funds rate as its main policy-making tool in the early 1990s.
Raising interest rates by 100 basis points will lead to a massive tightening of global funds, leading to a rapid inflow of the dollar to the United States.
In addition, the US interest rate hike will also cause panic and lead to exchange problems in many currencies. The euro-dollar exchange rate already touched the 1:1 level last week.
According to an Associated Press report on July 15, the exchange rate of the euro against the dollar has fallen to the lowest level in 20 years.
The Fed has been aggressively raising interest rates to bring down inflation, while the European Central Bank (ECB) has so far avoided sharp rate hikes. A weaker euro could be a pain for the ECB, as it could mean higher prices for imported goods, especially dollar-denominated oil.
For the US, a stronger dollar would also weaken the competitiveness of American products in overseas markets.
High inflation in the US, plus the Fed’s continued interest rate hikes, are all important reasons for the global sell-off of US debt.
Says Wang: “US Treasuries themselves are risk assets, so our holdings are also declining.”
A US National Debt Clock is erected on Sixth Avenue between 42nd and 43rd Streets in New York, updating the total US debt data in real time. At 10:30 am on July 20, this clock, which looks like an airplane dashboard, showed that the total US federal debt had exceeded the US$30.59 trillion mark, equivalent to 129.88% of US GDP.
For half a century, the US has been using the US debt in the form of investment products to support its currency.
Reducing holdings is a trend
Wang said it is a general trend for China to continue to reduce its holdings of US treasuries and have more flexible and diversified allocation of its overseas assets.
He said China could diversify to some investments, such as stocks in emerging markets, and appropriately increase its investments in the assets of countries that have good economic development prospects – Belt & Road countries, for example, and Southeast Asian countries that are relatively friendly to China.
At the same time, Wang also offered a reminder that diversification of overseas assets should not be rushed, as the matter “is easier said than done.”
Commenting on the impact of Sino-US relations on the reduction of China’s holdings of US debt, Wang said the China-US trade war was not the reason for China to slash its US debt holdings.
“In the past, China was relatively confident in the US dollar and debt and did not anticipate that the China-US relations would involve financial sanctions. But after Biden froze Russian and Afghan assets, people’s confidence in the dollar has declined,” Wang said.
“This is essentially an issue of China-US relations.” Tan Yaling, director of the China Foreign Exchange Investment Research Institute in Beijing, said in an interview with Hong Kong’s South China Morning Post on July 20.
Tan said “in the past, China held a large amount of US debt due to its good bilateral relations with the US, but now China may have to lower the risk that could be caused by conflicts with the US.”
Chinese treasury bonds have high yields
Wang said compared with US bonds, China’s treasurys are smaller in overall size but deliver stable and high yields. He said Chinese government bonds are popular as the RMB exchange rate itself is stable.
With the approval of the State Council, the Ministry of Finance will issue 23 billion yuan (US$3.4 billion) of government bonds in Hong Kong this year, compared with 20 billion yuan in 2021.
Wang stressed that Chinese government bonds are high-quality assets in the financial market.
Public information shows that China’s prices have remained stable under the global inflationary pressure.
According to the National Bureau of Statistics, China’s CPI rose by 1.7% on average in the first half of this year from the same period of the last year. The CPI in June was flat month-on-month. In the first half of the year, prices were generally stable within a reasonable range.
Jean Chia, chief investment officer of Bank of Singapore, wrote in a recent article published by the Financial Times: “Unlike other big countries, inflation is not the most worrying issue in China.”
Chia said the 2.5% CPI in June this year showed the resilience of China’s food and energy prices while there is ample room for China to achieve its GDP targets with fiscal and monetary stimulus.
She said the People’s Bank of China is the only central bank that has not raised interest rates to curb inflationary pressures. She said China has the ability to ease credit conditions by lowering interest rates, given that the yuan remains stable against a stronger dollar.
The Wall Street Journal reported that China’s inflation rate was slightly higher than expected in June due to higher food and fuel prices, but cost pressures remained small compared with high inflation in Europe and the US.
According to the annual economic report released by the Bank for International Settlements (BIS) recently, the world economy is facing the risk of entering a new period of high inflation.
Agustin Carstens, general manager of BIS, told the media in an interview that China had shown strong economic resilience against the backdrop of high global inflation while it had room to constructively adjust its monetary policy.
“China will continue to contribute momentum to global economic growth,” Carstens said.
Russia, Iran to abandon the dollar
It is worth mentioning that while China reduced its US debt holdings to below US$1 trillion, Russia and Iran said they would gradually abandon the use of dollars in their bilateral trade.
On the eve of Russian President Vladimir Putin’s visit to Iran, his press secretary Dmitry Sergeyevich Peskov said on July 18 that Russia and Iran would continue to develop bilateral relations and economic and trade ties.
Peskov said trade between the two countries grew 30% in the first half from a year ago. He added that both countries had taken steps to reduce the use of dollars in trade, aiming to fully abandon the use of the currency in future.
The deputy governor of the Central Bank of Iran for international affairs previously said Russia and Iran would settle bilateral trade in their local currencies and that they had already signed relevant agreements.
On July 19, Putin arrived in Tehran, Iran. On the same day, the two countries signed a memorandum of understanding worth about US$40 billion on natural gas cooperation.
Both Russia and Iran have been sanctioned by the US. Previously, Russia had officially launched the “gas for rubles” settlement mechanism. Russia’s self-operated domestic financial settlement system is now confronting the Western settlement system.
On the Iranian side (June 27), during the BRICS summit in Beijing, the Iranian Ministry of Foreign Affairs announced that it had applied to join the BRICS.
Commenting on “de-dollarization,” Wang called the US dollar still in a very strong position at the current stage.
He said it was difficult for other currencies to replace the dollar in the short term or have any large impact on the US currency. He said everyone was still using US dollars, especially in the financial sector.
According to Wang, “It is difficult for non-dollar currencies to replace the US dollar. In the past, it took a long time for the US dollar to replace the British pound. When other countries use other currencies to settle their trade, they will only form a partial substitution for the US dollar. It’s too early to say that they will be able to challenge the dollar’s status.”
Li Li is editor of Guancha.cn, which originally published this article in Chinese as an exclusive manuscript. It is republished in English translation here with kind permission. The content of the article is purely the author’s personal opinion, and does not represent the platform’s opinion. It may not be reprinted without authorization; otherwise, legal responsibility will be pursued.