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In: Economics

Why China does not sell its debt to US

Why China does not sell its debt to US

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Expert Solution

In the past decade, there has been no short of demands for the selling of US Treasuries in China, but such a decision would by no means be a strategic one. The main reason China can't consider selling its massive US debt is because other markets – spot, reserve, futures, and gold – don't have the ability to absorb such large assets. Which kind of reserves other than US Treasuries might be the latest foreign-exchange reserve option for China? Relevant choices and decisions have to make economic sense, not political sense. Indeed, some individual US congressman recently said China should relieve a large amount of US debt to pay for the costs incurred by the coronavirus pandemic on Americans. Any international assets that a nation holds may be exposed to political risks. From a market perspective, a single US politician's extreme statement should be seen as a possibility. These drastic statements do not impact investment decisions involving trillions of dollars however. It is also true that, despite the large holdings of US Treasuries, there have always been demands for China to sell US debt or alter its foreign exchange reserve structure. With reserves of more than $1 trillion, China is the second largest international holder of US Treasuries. The question of what the appropriate size is for China's foreign exchange reserves is hard to address. Through certain metrics the current size may seem a little large, but it may be smaller than predicted from some other angles. From a business perspective, it would cause confusion if the amount of China's reserves fell considerably. For that reason, China will still need to keep its foreign reserves above $3 trillion. China has also made some changes in this regard, including investing in some non-US debt and non-US assets. But the stability, profitability and liquidity management of these investments seems to have always faced difficulties over the years. The size of the European and Japanese bond markets might be big enough to accommodate such a large volume of assets, but the policy levels of the two economies have been negative for years, and so are their bond yields. The US Federal Reserve actually hasn't hit the level of negative interest rates. After consistently reaching record lows, the Treasury yield is still not negative. It's believed that China holds a considerable amount of European and Japanese bonds.  Now that the US dollar index is at a high point, current European and Japanese bonds may have an investment value from the exchange rate perspective, but in terms of credit risk, European debt and even some sovereign bonds may have a significant default risk. After all, they do not have separate monetary policies and EU regulations are seriously limiting their fiscal stimulus.


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