In recent months, there has been growing concern over China’s moves to reduce its holdings of US government debt. China has been the largest foreign holder of US Treasuries for over a decade, so any major changes in its purchasing behavior can have significant impacts on US financial markets.
What is happening with China’s US debt holdings?
China’s holdings of US Treasuries peaked at around $1.32 trillion in late 2013. Since then, China has reduced its total holdings of US debt. As of October 2022, China held $959.1 billion in US Treasuries, its lowest level since 2010.
This means China has cut its US debt holdings by over $360 billion in less than a decade. The pace of reductions has accelerated in recent months amid trade tensions between the US and China. From June to August 2022, China slashed its US Treasuries holdings by $113 billion to the lowest level since 2010.
China is not only buying fewer Treasuries at US government bond auctions, but it has also been allowing some of its existing Treasury holdings to mature without rolling them over into new notes and bonds. Both factors contribute to the drawdown of its US debt portfolio.
Why is China reducing its US debt holdings?
There are several potential reasons why China has been dumping US debt holdings:
- To retaliate against US trade policies and tariffs – The US-China trade war may be a factor spurring China to cut its exposure to US debt.
- To diversify foreign exchange reserves – China may be attempting to diversify its foreign exchange holdings away from the US dollar.
- Concerns over US fiscal policy – Large US government budget deficits could be a concern, motivating China to divest.
- Attractive yields elsewhere – Higher yields on other sovereign debt may be enticing China to shift holdings.
Most analysts believe China is primarily divesting US debt holdings as a retaliatory measure against escalating US trade tariffs. However, diversification and concerns over US fiscal policy are also likely contributing motivations.
What impact could this have?
China’s moves to dump US Treasuries could potentially impact financial markets in several ways:
- Higher US borrowing costs – Less demand for Treasuries from China may force the US government to increase interest rates offered on bonds to attract other buyers. This could raise borrowing costs.
- Weaker dollar – The US dollar could fall versus other major currencies as China diversifies into other assets.
- Volatile Treasury yields – Yields on Treasuries could become more volatile and spike sharply if China’s absence from bond auctions is not offset by other buyers.
- Stock market turbulence – Major stock indices could face increased volatility if China’s debt dumping causes financial market instability.
The actual impact thus far has been modest, with Treasury yields remaining fairly stable. But risks remain if China accelerates its reductions in US debt holdings.
Is this financially risky for China?
On the surface, China’s moves seem risky and counterproductive. The large sales of Treasuries holdings could depress prices for US debt, resulting in realized losses for China. There are a few mitigating factors, however:
- China has already seen major gains on past Treasury investments. From 2001 to 2010, China’s holdings quadrupled while Treasury prices also rose, allowing China to realize substantial gains.
- China maintains a strong net foreign asset position despite the Treasury sales. China’s reserves are still over $3 trillion, so it has ample firepower.
- Any losses may be acceptable to achieve broader strategic goals such as applying pressure on US trade policy.
In the near term, limited damage has been done to China’s balance sheet. But further escalation of US debt dumping could begin to pose bigger risks to China’s own finances.
Comparison of China and Japan’s holdings of US debt
It is also informative to look at China’s US debt holdings in the context of other major foreign creditors. Here is a comparison to Japan, the second largest foreign holder of US Treasuries:
| Holder | Total US debt holdings |
|---|---|
| China | $959 billion |
| Japan | $1.236 trillion |
This shows that while China has significantly reduced its overall holdings, Japan still maintains a considerably larger portfolio of US Treasuries. Japan’s holdings of over $1.2 trillion are roughly 30% higher than China’s current levels.
The following chart illustrates the respective trends in China and Japan’s holdings of US Treasuries from 2018 to 2022:
| Year | China Treasury holdings | Japan Treasury holdings |
|---|---|---|
| 2022 | $959 billion | $1.236 trillion |
| 2021 | $1.060 trillion | $1.276 trillion |
| 2020 | $1.061 trillion | $1.276 trillion |
| 2019 | $1.076 trillion | $1.197 trillion |
| 2018 | $1.118 trillion | $1.028 trillion |
This shows the stark contrast, with China aggressively paring its Treasury investments while Japan has maintained a relatively stable portfolio.
What might motivate Japan to cut its US debt holdings?
While Japan has not significantly reduced its holdings yet, there are some scenarios that could change its calculations:
- A major increase in yields for other sovereign debt outside the US, such as from the EU or emerging markets.
- Concerns over the US no longer upholding its defense commitments if the alliance with Japan sours.
- A major decline in the US dollar versus the yen, reducing the value of Treasury holdings.
- Japanese pension funds shifting asset allocations away from Treasuries and into higher-yielding securities.
For now, none of these scenarios appear imminent. But a deterioration of US-Japan relations or a fundamental shift in relative yields and currency values could eventually test Japan’s commitment to investing in US debt.
Conclusion
China has undertaken significant reductions in its US Treasury holdings over the past several years, largely motivated by escalating trade tensions. This has the potential to raise US borrowing costs and cause volatility in financial markets. However, the impact has been modest thus far. Looking ahead, further diversification by China could keep its US debt holdings at lower levels compared to the past decade.
In contrast, Japan has maintained a fairly stable portfolio of US Treasuries that still dwarfs China’s remaining holdings. But several scenarios exist where Japan could re-evaluate its exposure. Overall, shifts in foreign purchases of US debt bear close monitoring due to the potential repercussions.