China’s massive sell-off of US Treasuries.. What is the hidden truth?

U.S. President Joe Biden (first from right) is attentively listening to the remarks of Chinese President Xi Jinping (first from left) at the U.S.-China summit held on the sidelines of the Asia-Pacific Economic Cooperation (APEC) meeting in Woodside, near San Francisco, California, on the 15th. ⓒ AP/Yonhap News

China is embarking on a large-scale sell-off of U.S. Treasuries. For six months, China has maintained a net selling position (selling more than buying), causing the scale of China’s U.S. Treasury holdings to drop below $800 billion (approximately 1,033 trillion won) for the first time in 14 years.

China’s U.S. Treasury holdings were reported to be $778.1 billion as of September, according to Chinese economic media outlets such as the First Financial, citing statistics from the U.S. Treasury Department on the 17th. This is a 3.4% (or $27.3 billion) decrease compared to the previous month. This is the first time the $800 billion line has collapsed since May 2009 when it recorded $801.5 billion. Torsten Slok, an economist at Apollo Global Management, explained, “China has been selling off U.S. Treasuries at a rapid pace over the past few months as its growth momentum has slowed and its exports to the U.S. have also decreased, resulting in a decrease in dollars.”

China has been a major player in U.S. Treasuries since the early 2000s when the scale of U.S.-China trade began to grow rapidly. After joining the World Trade Organization (WTO) in 2001, China exported goods produced with cheap labor to the U.S. and used the money earned to buy U.S. Treasuries, considered a safe investment. The U.S., suffering from “twin deficits” in fiscal and trade, was able to keep interest rates low thanks to China’s Treasury purchases. It was a win-win situation for both the U.S. and China.

However, since Donald Trump’s presidency in 2017, the trade war between the two countries has escalated, leading to a sharp increase in China’s sale of U.S. Treasuries. China, which peaked at $1.3167 trillion in November 2013, maintained its Treasury holdings above $1 trillion until 2019, keeping its top spot in the holdings rankings.

Despite continuing to sell off U.S. Treasuries, China has ceded its top spot to Japan and even saw its holdings drop below $1 trillion in April last year. Particularly, China’s U.S. Treasury holdings have decreased by $173.2 billion last year and by another $88.9 billion so far this year. This means China’s U.S. Treasury holdings have plummeted by 40.9% over the past decade. As of September, Japan holds the top spot with $1.877 trillion, and the U.K. ranks third with $668.9 billion.

Cars for export are waiting to be shipped at Yantai Port in Shandong Province, China, on July 5. ⓒ Xinhua/Newsis

There are several factors at play in China’s continued reduction of U.S. Treasury holdings. There is an analysis that China is using the sale of U.S. Treasuries as a means to counteract U.S. attempts at derisking and export controls. Mingming, a senior economist at CITIC Securities in China, pointed out that “the U.S. has shown that it can have a financial impact on countries it considers enemies,” and that China is actually taking steps towards derisking.

If China sells off the massive amount of U.S. Treasuries it holds, it could cause a drop in the value of U.S. bonds and a rise in interest rates, increasing the U.S.’s interest burden. As the U.S.’s budget deficit widens due to conflicts such as the Ukraine war and the Israel-Palestine conflict, an increase in interest burden could inevitably destabilize the U.S. economy. It is suggested that this is part of China’s strategy to increase the burden on the U.S. government and shake the U.S. economy.

We cannot overlook the objective of defending the yuan exchange rate. China is buying yuan with the dollars obtained by selling U.S. Treasuries to prevent the currency from depreciating. This is to defend against the depreciation of the yuan due to the Federal Reserve’s high-interest-rate policy. Recently, the view that the main purpose is to defend against the depreciation of the yuan is prevailing.

China is struggling with massive capital outflows this year due to a slow economic recovery despite ‘reopening,’ excessive local debt, and a stagnant real estate market. The pressure for the yuan exchange rate to rise (value to fall) is high. The value of the yuan against the dollar has been showing a downward trend, falling 7.60% from 6.71 yuan in January to 7.22 yuan in June. The current yuan exchange rate is fluctuating around the 7.1 yuan line per dollar, exceeding the psychological support line of ‘poqi’ (breaking seven, the collapse of the yuan value of 7 yuan per dollar) set by Chinese authorities.

Moreover, as large Chinese real estate companies like Evergrande Group declare default, foreign capital is rushing out like a tide, exacerbating the weakness of the yuan. Bloomberg reported in September that the amount of yuan traded in the domestic spot and futures markets and the net yuan paid overseas totaled $75 billion. This is an 80% increase from the previous month and the highest level since 2016.

Employees are sorting out parcels at a logistics center in Zouping, Shandong Province, China, on the 10th, a day before China’s biggest shopping festival, Guanggunjie. ⓒ AFP/Yonhap News

As the Chinese government is pushing for the internationalization of the yuan against the ‘dollar hegemony,’ it is not pleased with the depreciation of the yuan value, leading to the sale of U.S. Treasuries and the purchase of yuan. As there is no sign of easing the yuan’s weakness, China has been making strenuous efforts to prevent foreign currency outflows due to the interest rate gap with the U.S., such as adjusting the foreign currency reserve ratio from the existing 6% to 4% in September. The Nihon Keizai Shimbun interpreted, “Chinese authorities have instructed state-owned banks to sell dollars and buy yuan to defend against the yuan’s weakness, and the banks have sold U.S. Treasuries to secure dollars for this purpose.”

Some observers believe that China’s sense of crisis over the ‘dollar weaponization’ following the Ukraine war has led to the sale of U.S. Treasuries. After Russia invaded Ukraine, the U.S. froze Russian overseas assets worth $300 billion. Wang Yuxin, a senior researcher at the Bank of China Research Institute, explained, “Holding too many dollar-denominated assets can expose us to greater risk in a situation where geopolitical conflicts are increasing,” and “If we increase strategic assets such as gold and oil, asset stability will increase.”

After the U.S. ousted Russia from the international financial system, yuan payments between Russia and China have surged, which also affected the reduction of China’s U.S. Treasury holdings. About 75% of trade between China and Russia was settled in yuan in the first half of this year, showing an increase in yuan payments. When China pays for oil and natural gas imported from Russia in yuan, Russia pays for cars imported from China in yuan, showing a complementary industrial structure between the two countries.

As a result, the internationalization of the yuan has gained momentum through yuan trade settlement with Russia. China’s efforts to shake the dollar hegemony, such as building a yuan payment system with the Middle East and South America, are also cited as the basis for ‘selling U.S. Treasuries.’ The share of yuan in international payments reached a record high of 3.71% in September, according to the Society for Worldwide Interbank Financial Telecommunication (SWIFT).

ⓒ Source: U.S. Treasury Department

In the midst of this, Chinese President Xi Jinping visited the People’s Bank and the State Administration of Foreign Exchange for the first time in his 10 years in power, which is seen as an effort to boost the yuan’s internationalization by selling U.S. Treasuries and buying yuan. Bloomberg reported, “One of the purposes of President Xi’s visit to the State Administration of Foreign Exchange this time is to better understand China’s foreign exchange reserves, which amount to $3 trillion.”

Despite the Chinese government’s efforts to defend the yuan exchange rate, experts predict that the yuan’s value is likely to fall further. As the People’s Bank’s financial easing policy lowers interest rates, there is growing interest in carry trades, where speculators borrow yuan to invest in currencies of countries with higher interest rates. Goldman Sachs is already providing investors with ideas to borrow yuan and operate in currencies of South American countries such as the Brazilian real. As carry trades increase, the yuan’s value can only fall.

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