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Why China wants to cut the US Treasury buys

Written by Mario Blascak, PhD | 2018-01-10 14:41:35 GMT

With China running massive current account surplus for decades, the FX reserves accumulation is the result. And the reserves of central banks are diversified, so it is a normal practice for central banks to hold other countries government debt in their portfolio to monetize the interest on their holdings.

After mounting the US Treasuries for years why would China want to decrease the volume of US Treasuries buying now? There are three reasons.

1. Holding the US Treasuries for blackmailing reasons

It is a common misunderstanding that holding country’s debt will eventually become the most effective tool for blackmailing the debtor. This is particularly true for populist politicians that use the argument of Chinese ownership of the US Treasuries as a scaremonger with the premise of China eventually buying all of the US.

The truths is that much simpler. Countries with massive current account surplus accumulate foreign exchange that is in turn invested in interest yielding securities. The US Treasuries are among the most stable and liquid securities and their availability and standardized market makes them the best investment vehicle. Especially for entities like central banks that seek diversity rather than return on their investment.

China’s current account surplus

2. US Treasuries enter long-term bear market

There is a reason though for China to change their strategy. After 25 years of rising bond yields market strategists including veteran bond trader Bill Gross, former chief investment officer of world’s largest bond fund PIMCO think that that’s it. This is the end of the bullish run and the bonds are entering the period of a bearish trend.

“Bond bear market confirmed,” Gross said in a Twitter posting on Tuesday, noting that 25-year trend lines had been broken in five- and 10-year Treasury maturities

Should China believe strategists like Bill Gross, the People’s Bank of China would have to start selling the US Treasuries from its portfolio. Such move would be considered even stronger market impulse than the Bloomberg news of “officials recommending to slow or stop US Treasury buying”. With China indicating the intention to sell part of its $1.2 trillion US Treasuries holding would really shake the markets and that is unlikely strategy for central banks ensuring market stability.

China’s holding of US Treasuries

It is not known why the Chinese officials would spur a cutback in the US Treasuries purchases yet, but the foreign holdings of US securities have already been a part of the geopolitical game in the past. Chinese officials are likely to factor issues like the outlook for supply of US government debt, along with political developments including trade disputes between the US and China when deciding whether to cut some Treasury holdings.

China’s FX reserves

3. Step ahead of policy change

The only reason why the nation like China with world’s largest FX reserves would want to diminish or stop the US Treasuries purchases is that the People’s Bank of China is getting ready for some kind of major policy overhaul. 

China is easing its financial conditions step by step. The People’s Bank of China actually follows Federal reserve in its own policy normalization. Should China be getting ready for some kind of currency easing, it would not need to add the US Treasuries to its FX reserves.

If this is the case, it is unlikely that policy relaxation would end up in renminbi long-term appreciation. The result is clear, the US Dollar would be the ultimate winner.    


Mario Blascak, PhD

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