China buys large amounts of U.S. Treasury debt to manage exchange rates and trade
the verdict
CONTESTED
contested - the weight sits with the supporting side
refutedsupported
the weight of evidence
2 sources for · 0 against
While evidence confirms China is a major holder of U.S. Treasury securities, it sparks debate and does not robustly substantiate the specific motivations concerning exchange rate and trade management.
Abstract America’s current-account deficit has grown significantly since 2020, reaching 3.6% of GDP last year – its highest level since 2008. At the same time, its net foreign debt reached a staggering $18 trillion, or 78% of GDP. And fast-rising inflation has prompted the US Federal Reserve to begin raising interest rates and reducing its holdings of Treasury securities – moves that are likely to impede growth and increase the government’s borrowing cost. Will America’s “external sustainability” be at risk again? To answer that question, we must consider the four variables on which external sustainability depends: the gap between private saving and private investment, the size of the budget deficit, investment-income levels, and the rate of GDP growth. Geopolitics might compound the challenges ahead. The US has avoided a balance-of- payments and dollar crisis in the past largely because Asian central banks and oil- exporting countries have tirelessly purchased US government bonds and Treasury bills. But amid rising geopolitical tensions, these buyers might decide – or be forced – to rethink their purchases. It is against this backdrop that the Fed is pursuing rather aggressive interest-rate hikes and quantitative tightening. But increased demand for foreign capital to finance the trade deficit, together with greater reluctance by foreign investors to purchase US government bonds and Treasuries, might put America in a quandary. It is likely that America’s external balance will deteriorate significantly, unless US GDP growth slows significantly.
As the second-largest holder of U.S. Treasuries, China’s investment behavior in U.S. debt has long sparked debate about whether economic factors or strategic considerations primarily drive it. Based on the “weaponized interdependence” theory, the paper uses the time-varying parameter regression (TVP-R) and vector autoregression (VAR) models to capture the influence of China-U.S. relations and economic factors on China’s holdings of U.S. Treasury securities. The results show that the scale of foreign exchange reserves and China-U.S. relations have a significant positive impact on China’s holdings. In contrast, the holdings are not sensitive to Treasury returns or the trade balance. The foreign exchange reserve scale has a far greater impact than the China-U.S. relationship. Dynamic analysis indicates that China-U.S. relations and China’s holding decision show a trend of “decoupling,” and there is no evidence to prove that China weaponized the creditor’s rights. China’s holdings of U.S. Treasuries should be mainly regarded as an economic behavior to preserve the value of foreign exchange reserves. In the future, the strategic competition between China and the U.S. may have only a limited impact on China’s holding behavior. Plain language summary This article aims to discuss the primary factors that determine the scale of China’s holdings of U.S. Treasury securities. From the theoretical perspective of “weaponized interdependence,” China’s holding behavior can be regarded as a potential political and strategic tool. The research indicates a clear positive correlation between the size of China’s foreign exchange reserves and the scale of its holdings of U.S. Treasury securities. Among all the factors considered in the study, the foreign exchange reserve is identified as the most significant factor influencing the scale of China’s holdings of U.S. Treasury securities. The correlation between China-U.S. relations and China’s holdings of U.S. Treasury securities is also positive, but the impact is not as pronounced as that of the foreign exchange reserve. In addition, the scale of China’s holdings of U.S. Treasury securities is not particularly sensitive to both absolute and relative returns or the trade balance. This suggests that, apart from investing in U.S. Treasury securities, China lacks relatively secure alternatives for managing its dollar reserves. Examining the temporal trends, the impact of changes in China-U.S. relations on the scale of China’s U.S. Treasury securities holdings has remained very low since 2018. There is a discernible trend of “decoupling” between the bilateral relationship and the scale of holdings and there is no evidence to prove that China weaponized the creditor’s rights. The impact of strategic competition between China and the United States on the scale of China’s holdings of U.S. Treasury securities may be relatively limited in the future. China is likely to remain one of the major creditors to the U.S., holding a substantial amount of U.S. Treasury securities, contributing to a certain degree of strategic stability in the bilateral relationship.
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