China's Large Position in U.S. Treasuries
The United States’ debt load has risen substantially since the start of the milennium, 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 – $16.74 trillion as of October 2013 - it should come as no surprise that the largest investors in U.S. Treasuries are other governments and central banks.
China, which owns an estimated $1.28 trillion in U.S. Treasuries, is the number-one investor among foreign governments, according to the July 2013 figures released by the U.S. Treasury. This amounts to over 22.8% of the U.S. debt held overseas and nearly 8% of the United States’ total debt load.
Are These Big Numbers 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.
Further, China continues to generate a massive amount of dollar earnings by virtue of its huge trade surplus with the United States. These dollars need to be invested somewhere, and the U.S. Treasury market – due to its enormous size – is one of the few places that China can recycle its surplus greenbacks. Consider, for example, that the Australia’s bond market is only about 3% as large as the U.S. bond market. If China were to try to funnel more cash into the Australian bond market – or that of another smaller nation – the impact of its buying would be enormous, and it would disrupt the entire market. The U.S. bond market is one of the few in which this isn’t the case, which explains why over 40% of the country's total reserves are invested in Treasuries.
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 US debt default to ensure the safety of Chinese investments in the United States.” This helps demonstrate that China will indeed take steps to influence the course of events in the United States when it feels its interests are threatened.
An Alternative View
Another take on the China issue comes from Thomas Donlan's editorial "Second Grade Arithmetic" in the December 8, 2012, issue of Barron's:
"It's an ominous sign, by the way, that China has curtailed its role as the chief enabler of the U.S. borrowing addiction -- and even more ominous that few Americans have even noticed. Between September 2011 and September 2012, China reduced its holdings of U.S. Treasury debt 9%, from $1,270 billion to $1,155 billion. ... we had better hope the rest of the world does not join in."
True enough, but also keep in mind that even as China reduced its position by 9.1% in the period cited, the yield on the 10-year U.S. Treasury fell from 1.92% to 1.64% as its price rose. (Keep in mind, prices and yields move in opposite directions.) This indicates that at least so far, large selling by China hasn't had a major impact on the bond market.
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. Still, China there is little reason to expect that the country will engage in any actions that would amount to economic warfare. Individual investors would therefore be well-served to take any discussion of this issue with a grain of salt, and to construct their bond portfolios based on their own individual needs rather than broader global trends.