Many fear that China’s ownership of U.S. government bonds will give it economic influence over the United States. But this concern stems from a misunderstanding of government debt and how states derive power from economic relationships. Foreign purchases of sovereign debt are normal transactions that help maintain the openness of the global economy. As a result, China’s share of US debt is binding rather than divisive in the bilateral relationship between the two countries.
Even if China wanted to “attract” financing, the use of credit as a coercive tool is complex and often subject to significant constraints. A creditor can dictate terms to a debtor country only if the debtor has no other choice. In the case of the United States, U.S. government debt is a widely held and highly desirable asset in the global economy. Whatever bonds China sells are simply bought up by other countries. For example, in August 2015, China reduced its holdings of US Treasuries by approximately $180 billion. Despite its size, this decline did not have a significant impact on the U.S. economy, so such actions had limited impact on U.S. decision-making.
In addition, China needs to hold large amounts of U.S. Treasuries to manage the renminbi’s exchange rate. If China were to suddenly release its foreign exchange reserves, the exchange rate of its currency would appreciate, raising the prices of Chinese exports in foreign markets. Therefore, China’s holding of U.S. government bonds does not give it undue economic influence over the United States.
Why do countries accumulate foreign exchange reserves?
Countries that trade openly with other countries are more likely to purchase foreign government bonds. From an economic policy perspective, a country can have two of the following: a fixed exchange rate, an independent monetary policy, and free capital movements, but not three. Foreign government bonds provide countries with the means to pursue their economic goals.
The first two functions are monetary policy choices carried out by a country’s central bank. First, sovereign debt often forms part of other countries’ foreign exchange reserves. Second, central banks purchase government bonds as part of their monetary policy to maintain exchange rates and avoid economic instability. Third, sovereign debt is equally attractive to central banks and other financial actors as a low-risk store of value. Let’s briefly explain each of these features.
foreign exchange reserves
Countries that are open to international trade and investment need to have a certain amount of foreign currency on hand to pay for foreign goods and investments abroad. As a result, many countries have set aside foreign currency to pay for these costs, cushioning their economies from rapid changes in international investment. Domestic economic policy often requires central banks to maintain reserve sufficiency ratios of foreign currency and other reserves for short-term external debts and to ensure the country’s ability to service short-term external debts in times of crisis. . The International Monetary Fund publishes guidelines to help governments calculate appropriate foreign exchange reserves given economic conditions.
exchange rate
A fixed or fixed exchange rate is a monetary policy decision. This decision is aimed at minimizing price volatility associated with volatile capital flows. The situation is particularly acute in emerging markets, where in 2013 Argentina’s import prices rose by up to 30%, leading opposition leaders to describe wages as “like water running through your fingers”. Because price fluctuations are economically and politically destabilizing, policymakers manage exchange rates to mitigate fluctuations. Internationally, there are very few countries where exchange rates are completely “floating”, i.e. determined by the currency market. To manage domestic currency rates, countries may choose to purchase foreign assets and store them for the future when their currencies may depreciate too quickly.
Low-risk store of value
Because sovereign debt is backed by the government, private and public financial institutions view sovereign debt as a low-risk asset with a high probability of repayment. Some government bonds are considered riskier than others. A country’s external debt may be deemed unsustainable relative to its GDP and foreign exchange reserves, or the country may default on its debt. However, sovereign bonds are generally safer, as they are more likely to return in value than other forms of investment, even if they do not pay high interest rates.
Why is China buying US government bonds?
China buys U.S. bonds for the same reasons other countries buy U.S. bonds, with two caveats. The devastating Asian financial crisis of 1997 prompted Asian economies, including China, to accumulate foreign exchange reserves as a safety net. More specifically, in order to prevent cash inflows from trade and investment from destabilizing the domestic economy, China has accumulated huge foreign exchange reserves over time, such as by maintaining a current account surplus. is held.
China’s large holdings of US debt say as much about the power of the US in the world economy as it does about the peculiarities of the Chinese economy. Broadly speaking, U.S. government bonds are assets in demand. It’s safe and convenient. As the world’s reserve currency, the US dollar is widely used in international transactions. Trade goods are priced in dollars, which are easily converted into cash due to high demand. Additionally, the U.S. government has never defaulted on its debts.
Conversation with Scott Miller
0:12 – Could China use its creditor status as a means of power and influence over the United States? 2:09 – Why do countries buy each other’s debts? 3:40 – Could China use its creditor status as a means of power and influence over the United States? What would happen if we sold U.S. Treasuries? How would our economies be affected? 5:43 – Even though the U.S. dollar is no longer the world economy’s reserve currency, countries will still be eager to buy U.S. Treasuries. Would you buy it?
Despite the attractive nature of U.S. Treasuries, economists worry that a sudden halt to capital flows into the U.S. could trigger a domestic crisis, raising concerns about continued debt financing. I’m holding you. Therefore, US reliance on debt financing would pose a challenge not if demand from China stopped, but if demand from all financial entities suddenly stopped.
From a regional perspective, Asian countries are burdened with unusually large amounts of US debt following the 1997 Asian financial crisis. During the Asian financial crisis, inflow investment in Indonesia, South Korea, Malaysia, the Philippines, and Thailand plummeted from $93 billion to an estimated minus $12.1 billion, equivalent to 11% of their total pre-crisis GDP. In response, China, Japan, South Korea, and Southeast Asian countries maintain large precautionary foreign exchange reserves, including U.S. Treasury bonds, for security and convenience. These policies were vindicated after his 2008 years, when Asian economies enjoyed a relatively rapid recovery.
From a national perspective, China buys US government bonds because of its complex financial system. The central bank must buy U.S. Treasuries and other foreign assets to prevent cash inflows from causing inflation. In the case of China, this phenomenon is rare. Countries like China, which save more than they invest domestically, are typically international lenders.
To avoid inflation, China’s central bank removes this inflow of foreign currency by buying foreign assets, including U.S. government bonds, in a process called “sterilization.” This system has the disadvantage that the return on investment is unnecessarily low. By relying on FDI, Chinese companies borrow from abroad at high interest rates, while China continues to lend to foreign companies at low interest rates. The system also forces China to buy safe and convenient foreign assets, including U.S. Treasuries.
Who owns the most U.S. government bonds?
Approximately 70% of U.S. Treasuries are held by financial institutions and institutions within the United States. U.S. Treasury securities are convenient, liquid, and low-risk stores of value. These properties make them attractive to a wide variety of financial actors, from central banks who want to hold their funds in reserves to retail investors who want a low-risk asset in their portfolios.
Of all public agencies in the United States, government holdings, including Social Security, hold more than one-third of U.S. Treasury securities. The Secretary of the Treasury is legally required to invest Social Security tax revenues in U.S.-issued or guaranteed securities held in trust funds administered by the Treasury Department.
The Fed holds the second largest share of U.S. debt, accounting for about 13% of total U.S. debt. Why do countries buy their own government bonds? As the central bank of the United States, the Federal Reserve must adjust the amount of money in circulation to match the economic environment. Central banks perform this function through open market operations. That is, they buy and sell financial assets, such as Treasury bills, to add or remove money from the economy. By purchasing assets from banks, the Federal Reserve puts new money into circulation so that banks can make more loans, stimulate business, and support economic recovery.
Besides the Federal Reserve and Social Security, many other U.S. financial entities hold U.S. Treasury securities. These financial players include state and local governments, mutual funds, insurance companies, public and private pension plans, and U.S. banks. Generally speaking, they will hold US Treasury securities as low-risk assets.
The biggest impact of China’s large-scale dumping of U.S. debt would be that China would actually export fewer products to the United States.
– Scott Miller
Overall, foreign countries make up a relatively small share of U.S. debt holders. Over the past few years, China’s holdings have accounted for just under 20% of foreign-owned U.S. debt, but only 3% to 6% of total U.S. debt. China’s holdings fell to $859 billion in January 2023, the lowest level since 2009. Additionally, Japan has at times overtaken China to become the largest holder of U.S. debt. This situation has continued since June 2019, as Chinese stock holdings have decreased while Japanese stock holdings have increased.
Internationally, this situation is common. In other words, most government bonds are held domestically. European financial institutions hold the majority of European government bonds. Similarly, Japan’s domestic financial institutions hold approximately 90% of Japan’s net government debt. Therefore, despite the international demand for US sovereign debt, the US is no exception to the global trend. The majority of U.S. sovereign debt is held by parties within the United States. 
