How to view China's reduction of U.S. debt holding

15:22, February 23, 2010      

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China trimmed its holding of U.S. debt by 34.2 billion U.S. dollars or 4.3 percent to 755.4 billion dollars in December last year, whereas Japan boosted its holdings of U.S. Treasuries by 11.5 billion dollars to 768.8 billion dollars in December 2009 to outpace the former as the largest holder of U.S. Treasury securities, according to the Treasury International Capital (TIC) report released on Feb. 12, and the foreign holding of U.S. Treasury securities fell by 53 billion dollars in the month.

This new trend, however, has attracted widespread attention globally, as China is still a big holder of U.S. debt bonds, which currently owns 10 percent of the total U.S. Treasury securities in circulation.

From a business investment point of view, the timing for China's substantial reduction of its holding of U.S. security bonds is appropriate. The nation has made a correct choice to cut its U.S. debt holding at the time when there is a rising demand for hedge dollar due for a technical demand.

Of late, the euro slid to a nine-month low against the U.S. dollar. Greece's debt binge and the short-term sovereign debt crisis in several nations of the euro zone has led to a drastic slump in the value of euro and pushed up the U.S. dollar's rally. Thanks to an increasing demand for U.S. treasury hedge and in view of a technical rebound for the U.S. dollar, it is a right, opportune time to sell the US dollar.

This represents an especially-correct investment strategy for China, which now has a large amount of U.S. treasury securities. China has sold merely 4.3 percent of its U.S. dollar-denominated assets. As a matter of fact, the amount of Treasury securities it has cut is still limited. So, it has neither negatively affected the dollar's exchange rate price nor meted out a telling blow to the U.S. dollar. This has precisely shown the reduction of China's holding of US security bonds is quite modest and moderate.

U.S. dollar has kept showing a bearish trend on a long run. After the onset of the global financial crisis in 2008, the U.S. debt levels, instead of being trimmed by a big margin, have further expanded from the private sector into the public sector.

The size of the American government's debt and budge deficit, presently under constant expansion, can only be emergency rescued by the issuance of U.S. dollars, which would certainly lead to the devaluation of the dollar-denominated assets and subsequently cause creditors to drastically contract the dollar-denominated assets in their possession.

At present, the U.S. government's total debt amount has surpassed the 12 trillion dollars mark, constituting approximately 90 percent of its gross domestic product (GDP). The U.S. government budget deficit is expected to top record 1.56 trillion dollars at least in the fiscal year 2010, or about 10.6 percent of its GDP, with its debt limits rising to a historic 14.3 trillion dollars in the post-World War II era.

In this contest, the Chinese government, out of its consideration for the maintenance of the reserve security and appreciation, has worked out the policy to slowly expand or reduce U.S. debt. Hence, it is a rational choice proceeding from the perspective of its own economic and financial interests, which should not be read and mulled over excessively.

In fact, the increased size of U.S. dollar-denominated debt and fiscal deficit has triggered growing concerns of the international community. India trimmed its holding of U.S. debt by 1.3 billion dollars in November last year and, in December 2009, Russian Federation also cut its holding by 9.6 billion dollars. The U.S. debt issuance rose four-fold in 2009 than in the preceding year, as the latest research findings have reportedly indicated. But in years prior to 2009, foreign counties subscribed almost 100 percent of the U.S. treasury securities and, since early 2009, however, this "main force" had only bought less than one third of U.S. treasury securities.

An extremely embarrassing situation that has been emerged is that almost all global investors have been caught in the U.S. dollar "kidnapping" dilemma or impasse. To date, nevertheless, not a single currency has so far been able to replace the U.S. dollar's status and the American treasury debt bonds remain a good investment channel for countries worldwide.

In a short term point of view, China's current holding of U.S. Treasury bonds does not mean to forsake the country's investment in U.S. dollar-denominated assets. This is because, if China scales down or continues to substantially sell out bonds within a short time, it could cause an adverse effect to the dollar assets. In the long run, China's foreign exchange (Forex) reserve needs to be further optimized, and there is also a need to gradually cut the dollar-denominated assets in a bid to diversify Forex assets, but this is perhaps a prolonged and gradual process.

In a nutshell, the reduction or diversification of investment is merely the means to "symptoms", and the way for genuinely resolving the real issue is the fundamental solution to the irrational internal and external imbalance of Chinese economy. So, this requires China to accelerate the pace for its economic restructuring toward a basic balance in the international payments and to avoid a substantial increase in Forex reserve.

In the meanwhile, China should speed up the pace for internationalization of the Chinese currency RMB (or Renminbi), reduce its demand for the U.S. dollar and the ratio of U.S. dollar to its payment surplus, so as to alleviate an increasing economic pressure resultant from the pressure of the country's external imbalance.

By People's Daily Online and contributed by Prof. Shi Jianxun, a noted economist and an especially PD-invited guest commentator
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