At the end of June, China held 776.4 billion U.S. dollars in U.S. treasury bills, according to the Treasury International Capital System (TICS) of the U.S. Treasury Department. Although China remains the world's largest U.S. treasury bill holder, it has reduced its holdings by 25.1 billion U.S. dollars or over 3 percent less from that of the end of May, the biggest monthly drop since the TICS data system was launched in March 2000.
What are the reasons behind the drastic reduction in the holdings of U.S. treasury bills? What impact will it have on the market? The People's Daily conducted special interviews on this topic with Ba Shusong, deputy director of the Financial Center of China State Council's Development Research Center, Tang Min, deputy secretary-general of the China Development Research Foundation, and Guo Hongyu, director of the Monetary Economics Department under University of International Business and Economics.
The reduction was a periodic adjustment
Question: China started to increase its holdings of U.S. treasury bills in July 2008, with extra purchases totaling 300 billion U.S. dollars within a year; why did China then drastically cut its holdings?
Ba Shusong: The investment portfolio and its adjustment of foreign exchange reserves should be determined from a long-term, comprehensive and strategic perspective; the investment of foreign exchange reserves should not be treated with a short-term view. In terms of trends, following the gradual recovery of China's exports, China's special trade structure will enable China to enjoy a fairly long-term trade surplus. Furthermore, China's taking the lead in recovery has created a trend for the inflow of foreign investment to resume. Under the existing exchange rate mechanism, the double surplus in the balance of international payments will re-emerge. The increase in foreign exchange reserves that is driven by the double surplus will put heavy pressure on the handling of China's foreign exchange reserves. Therefore, if only foreign exchange reserves show a consistent upward trend, increasing holdings of U.S. dollars will be an inevitable choice in the current international financial system. Although there was a drop in the holdings of U.S. treasury bills, the investment is likely to be shifted to U.S. dollar-dominated financial instruments, indicating that reliance on the U.S. dollar has not dropped noticeably.
Therefore, prior to a remarkable improvement in the existing international monetary system, the U.S. dollar is likely to remain the primary reserve currency of developing countries including China despite unreasonableness in the structure. Within this trend, either reducing holdings or increasing holdings could usually be only deemed as a periodic adjustment.
Tang Min: Reducing holdings in June was a marginal adjustment; the holdings cut accounted for just three percent of the U.S. treasury bills owned by China. In fact, China's U.S. treasury holdings have fluctuated. The holdings cut in June was neither the first nor the last reduction. In April 2009, China cut its holdings by 4.4 billion U.S. dollars, yet increased its holdings in May by 38 billion U.S. dollars. Thus, fluctuations in China's U.S. treasury holdings are simply normal operations as part of China's foreign exchange investment and foreign reserve management, and routine adjustments according to China's foreign exchange supply and demand. They should not be considered as a long-term structural change.
Guo Hongyu: Technically, reducing holdings also indicates that China is adjusting the foreign exchange structure or the asset structure of foreign exchange reserves. In the long term, reducing financial assets, expanding foreign investment and purchasing more real enterprises and strategic resources are both the direction for the structural adjustment of China's foreign exchange reserves and a requirement for China's economic sustainable development.
"Dumping short-term U.S. treasury bills and buying long-term such bills" is incorrect.
Q: Structurally, China "dumped long-term U.S. treasury bills and bought short-term such bills" in the first quarter, but made adjustments and "dumped short-term U.S. treasury bills and bought long-term such bills" in June. What's the reason behind this change?
Tang: The idea of "dumping short-term U.S. treasury bills and buying long-term such bills" is incorrect. In fact, many short-term U.S. treasury bills expired, so they were naturally sold out, not "dumped." In June, China actually bought a large number of long-term U.S. treasury bills. In terms of future prospects, the possibility of the emergence of inflation in the U.S. is small over the next year, so is that of an increased interest rate by the Federal Reserve. At this point, China would have relatively lower gains if holding too many short-term treasury bills. I believe that based on the judgment of the future interest rate trend and in terms of the management of foreign exchange reserves, it is understandable if China intends to hold less short-term U.S. treasury bills and more long-term such bills.
Guo: The approach of selling short-term U.S. treasury bills and buying long-term such bills seemed to indicate China's cautious attitude towards the recovery of the world economy. This is because interest rates may only be reduced rather than raised under the circumstances of an economic downtown. Therefore, it is safer to hold long-term bills.
The reduction will not become a long-term operation
Question: Will reducing treasury holdings lead to market fluctuations and will it become a long-term market operation?
Ba: In terms of the structure of U.S. treasury bills purchasers, since 2009, U.S. domestic residents and agencies have in fact become the main buyers of U.S. treasury bills. The adjustment made by China's investment agencies to foreign exchange reserves during a certain period of time will not significantly impact the U.S. Treasury bill market, but it will increase the fluidity of the U.S. financial market.
Tang: China's monthly transactions are only a part of the enormous U.S. Treasury bill market. Buying and selling are normal market operations. It is just like the business of ordinary people on the stock market. Some people buy more and some sell more. This is very normal behavior for investors. In fact, Japan increased its holdings of U.S. treasury bills by 34.6 billion U.S. dollars in June, far more than the number China reduced.
Guo: If market behavior reflects the expectation of main investors, reducing holdings of dollar bills may be a strategy at least for a certain period of time, which will have a relatively large impact on the bond market.
The need for structural reform
Question: In your opinion, how could China's U.S. government debt holding operations be more normal, scientific and in accordance with market rules?
Tang: China buying U.S. government debt is not an expedient measure, but rather a very important part in China's long-term foreign exchange reserves management strategy. China has accumulated a lot of experience over a long period of time. The current operations are quite normal and in accordance with market rules. Generally speaking, U.S. government debt has many advantages such as low risk and good liquidity. So, it is not only China, but all countries that are viewing U.S. government debt as a very important part of their foreign exchange reserves. If we merely regard U.S. government debt as a type of investment, it is also relatively stable and quite good, and is certainly the most important part in China's foreign exchange reserves investment portfolio.
Ba: Too large foreign exchange reserves make investing more difficult in the microcosm and lead to a loss to the national welfare in macrocosm. Strategically, China should encourage its residents and enterprises to have larger rights to use foreign exchange, and stop the government holding too much foreign exchange. While actively attracting foreign capital, China should also encourage investment in foreign countries. Meanwhile, RMB exchange rates should be sufficiently flexible. In terms of economic structure, China should expand its domestic demand and consumption and should no longer excessively depend on exports. Reforms in economic structure must be carried out to realize these goals.
Guo: If China wants to have the initiative, it must do well in two ways. Firstly, it must expand domestic demand and decrease its trade surplus. Secondly, it must expand its export of capital and change its monetary assets into physical assets such as land, mines and enterprises. Then, China will be able to reduce its dependence on the U.S. dollar.
By People's Daily Online
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