By Thomas Kenny
China’s Large Position in U.S. Treasuries
The United States’ debt load has risen substantially since the start of the millennium raising concerns about the country’s long-term financial health. But who owns all of this debt? A nation’s debt is, after all, the total of bonds that the country has issued. Given the size of the U.S. debt – $17.6 trillion as of June 30, 2014 – it should come as no surprise that the largest investors in U.S. Treasuries are other governments and central banks.
China, which owned an estimated $1.268 trillion in U.S. Treasuries, is the number-one investor among foreign governments, according to the June 2014 figures released by the U.S. Treasury. This amounts to over 21% of the U.S. debt held overseas and about 7.2% of the United States’ total debt load.
Why These Big Numbers Aren’t Necessarily a Problem
There are two reasons why China’s huge investment in U.S. government bonds has stirred controversy in recent years.
First, if the country stops buying or elects to sell even a small portion of its position, Treasury prices would fall and yields would rise. The result of higher rates, in turn, would likely be slower economic growth and higher borrowing costs for the U.S. government.
Second, China’s huge Treasury position is seen as leaving the United States economically vulnerable to the decisions of a foreign government.
That may seem like a potential danger until you consider why China is buying so much U.S. debt. The reason is highly technical in nature, but the short answer is that China is buying Treasuries to help depress the value of its currency (the yuan). A cheaper yuan makes the country’s exports less expensive for foreign buyers, thereby keeping the country’s export-based economy chugging along.
Consequently, the Chinese economy would suffer as much, if not more than, that of the United States if China were to suddenly stop buying U.S. debt.
It’s also important to keep in mind that since China holds such a large position in U.S. debt, the nation has a vested interest in maintaining the health of the Treasury market. Naturally, this provides ample motivation for China to avoid any action that would cause Treasury prices to plunge.
Having said that, China did utilize its large position in Japanese government bonds to influence discussions surrounding Japan’s purchase of disputed islands during September 2012. In addition, the Chinese government felt compelled to comment on the U.S. debt ceiling debate in October 2013. With under two weeks to go until the United States would have exceeded the limit, thus raising the possibility of a default, China’s Vice Foreign Minister, Zhu Guangyao, warned U.S. politicians that “the clock is ticking” and said, “We ask that the United States earnestly takes steps to resolve in a timely way the political issues around the debt ceiling and prevent a U.S. debt default to ensure the safety of Chinese investments in the United States.” This helps demonstrate that China may indeed try to influence the course of events in the United States when it feels its interests are threatened.
What if China is Forced to Stop Buying U.S. Treasuries?
One aspect of China’s economy argues against its being able to invest as much in Treasuries as it did in the 1990s and 2000s. For years, China generated a massive amount of dollar earnings by virtue of its trade surplus with the United States. These dollars need to be invested somewhere, and the U.S. Treasury market – due to its enormous size – was one of the few places that China could recycle its surplus greenbacks without disrupting the market. Today, however, China’s trade surplus is shrinking – and that means fewer dollars to invest in Treasuries.
Learn more about this issue, and its potential market impact, in my article Why China Will Buy Fewer U.S. Treasuries in the Years Ahead.
Don’t Overemphasize Global Trends
The bottom line: the soaring level of U.S. debt is problematic, and to many citizens, the high percentage of Treasuries now owned by a rising economic rival is even more troublesome. While there is little reason to expect that China will engage in any actions that would amount to economic warfare, it may nonetheless be compelled to buy fewer Treasuries due to its decreasing trade surplus.
That said, individual investors are always better served by constructing their bond portfolios based on their own specific situation rather than news headlines or broader global trends.