Question

China currently holds the most U.S. debt due to a variety of factors, including China’s desire to keep the yuan weak compared to the dollar. Why do you think China has so much dollars? How can you explain that by buying a lot of Treasury securities, China can keep the Yuan low?

Answer 1

Currency devaluations can be used by countries to achieve economic policy. Having a weaker currency relative to the rest of the world can help boost exports, shrink trade deficits and reduce the cost of interest payments on its outstanding government debts.

The American tariffs on China slow China's growth, weakening its currency and making the American dollar relatively strong. A stronger dollar cuts into inflation in the United States, and it might force the Fed to cut interest rates by more than it would otherwise to sustain its desired pace of growth and price gains.

China is primarily a manufacturing hub and an export-driven economy. Trade data from the U.S. Census Bureau shows that China has been running a big trade surplus with the U.S. since 1985. This means that China sells more goods and services to the U.S. than the U.S. sells to China. Chinese exporters receive U.S. dollars (USD) for their goods sold to the U.S., but they need Renminbi (RMB or yuan) to pay their workers and store money locally. They sell the dollars they receive through exports to get RMB, which increases the USD supply and raises demand for RMB.China's central bank (People’s Bank of China – PBOC) carried out active interventions to prevent this imbalance between the U.S. dollar and yuan in local markets. It buys the available excess U.S. dollars from the exporters and gives them the required yuan. PBOC can print yuan as needed. Effectively, this intervention by the PBOC creates a scarcity of U.S. dollars, which keeps the USD rates higher. China hence accumulates USD as forex reserves.