Ichiro Suzuki
Several years ago already, China ceded the status as the largest holder of US Treasury securities. Japan regained the top spot that it once held before the rise of the People’s Republic. After a surge in its U.S. Treasury securities holding, Beijing began to think that it was not right to place its vast wealth in assets of a country that was increasingly seen as a strategic rival.
China, therefore, began to diversify their assets in its foreign exchange reserves, away from T notes and bonds. China’s current holdings of Treasury securities at $750 billion is down by 30% of what they once were. After aggressive build-up of gold reserves, China’s position is now estimated at over $200 billion. While this is an asset that everyone loves, gold has a drawback of limited supply that caps the size of the market. So China or not, one can go only so far on gold. Then where can the money go? There are no rivals to U.S.Treasury securities in terms of the depth of the market, in size and liquidity to be specific. Australia, Canada, Denmark, Germany, Switzerland, Norway, Sweden, etc. are AAA-rated but their combined market size is still no match for the U.S. In addition, China already has a fair position in Germany and Switzerland. Japan has a sizable sovereign debt market as the most indebted country on earth. Compromising on quality, China reportedly has increased its position on Japan earlier in this decade. The Japanese yen has suffered a sharp decline since 2022. So it was a cost of compromise. The Euro-zone as a whole represents the second largest bond market. Geopolitical risks are rising in recent years due to Russia’s aggression in Ukraine, and trade tensions between the EU and China are growing. Europe and China might nonetheless get closer due to clouds spreading over the Atlantic alliance. As Europe increases defense spending, greater military prowess might enhance its status as a reserve currency. It would be even better if the monetary union moves toward commonly issued bonds. China may allocate more funds to Germany, the U.K. and Switzerland. Where else can they go? China’s other trading partners and BRI recipients offer neither safety nor liquidity. Would Beijing be interested in ruble bonds issued by Russia even if this country is China’s ally?
No one knows how China has been cutting back on its U.S. Treasury securities holdings. China still wants to let the world be known that the size of the holdings has been in decline. Recently it is believed that China is parking their massive holding of T-notes and bonds in domiciles outside of China, notably Cayman Islands and possibly Luxembourg. Diversification of domicile gives them better optics though this conduct belongs in the same realm of fudging economic statistics. Few take China’s numbers at face value. The very basic problem is that under its policy of driving exports hard, China’s external surpluses have become too large to handle. China can hold all those reserves in its own currency. Conversion into the RMB, however, would cause sharp appreciation of the currency, and this is not something that the CCP wants to see. This is a dilemma of a mercantilist export machine.
The best solution to relieve the country from this problem is to import more to reduce the size of surpluses. Xi Jinping and the Communist Party are well aware of it and have been floating an idea of promoting private sector consumption. Reawakening Chinese consumers is, however, easier said than done. President Xi might not be fully aware how daunting a challenge that China faces today. The Chinese economy is mired in mild deflation as a result of a historic debt-fueled bubble’s bust. The household sector’s balance sheets are severely impaired as prices of their houses have been under intense downward pressure while their salaries don’t rise or, in worse cases good jobs are hard to find for those without one. Chinese households are in no mood to boost spending, preferring to increase cautionary savings. On top of it, working age population has been falling already for a decade and the entire population has peaked out a few years ago. This is worse an ordeal that Japan had suffered at around the turn of the 21st century. Japan at least didn’t have to work out debt amid declining population. Population began to fall after non-performing loans were cleaned up. China is truly caught in an uphill battle.
Beyond U.S. Treasury securities and gold, little is known about China’s foreign exchange reserves. They have peaked out in 2014 at $3.8 trillion and then fell to $3.0 trillion in 2016. It is believed that the People’s Bank of China intervened in the market by selling the dollar and buying the RMB amid growing downward pressure on the currency. Size of FX reserves has been consistent since then despite sizable current account surpluses every year, 3.2% of the economy in 2024. There is a reasonable chance that the PBOC has been regularly intervening in the markets to keep the RMB in a certain, relatively narrow range. Currencies in the basket of the IMF’s special drawing rights (SDR) are supposed to be free float but China has no interest in letting the RMB be traded freely. Wealthy people are getting their money out of China outside of an officially allowed channel, making a dent on the external accounts. China doesn’t afford to let the market decide the RMB’s value for fear of capital flight. Stock of foreign direct investment is believed to be included in FX reserves, whereas it isn’t’ for other countries. While foreign capital flooded into China in early years of the 21st century, very few net inflows are taking place these days due not only to the economy’s marked deceleration from its heyday but also to wolf warrior diplomacy that has increased risks of doing business in the mainland. China’s FX reserves might not be as robust as they appear on the surface.
About the author: Mr. Suzuki is a retired banker based in Tokyo, Japan.
Comments