China Losing Taste for Debt From U.S.

The New York Times (see "China Losing Taste for Debt From U.S.) published an article this morning that highlights China's declining appetite for US debt. Currently, approximately 60-70% of China's $1.9 trillion surplus is invested in US government and agency debt. For the last few months, China has been quietly reducing its exposure to US agency debt, but continued to be a voracious buyer of treasuries. In fact, in September China surpasses Japan as the largest holder of US treasury bonds (incidently, Japan has been reducing its exposure to US gov't debt). China holds $585mm of US treasuries vs. Japan at $573mm.

However, recent comments from Chinese policy makers signal that perhaps China may seek (or be forced) to reduce its exposure to US treasury bonds. A couple key points support this argument:

1. China will need to fund its recently announced 4 trillion yuan (~$600mm) economic stimulus package. Reducing its holdings of foreign currency reserves is a natural way to pay for this ambitious spending plan.

2. A slowdown in the Chinese economy will reduce the growth in the country's foreign reserves. China's average monthly trade surplus could fall to less than $20bn/month, well short of the $50bn/month China invested abroad during the 1st half of 2008.


3. China predominately funds its foreign reserves by requiring the banking sector to essentially hand over 20% of its deposits to the country's central bank. However, the article suggests that "the central bank is rapidly reducing this requirement" and pushing banks to lend directly to domestic Chinese companies.

4. Finally (and certainly the greatest long-term threat to the US dollar) is China's concern over the US's ballooning national debt (currently $10.6 trillion). With a $1+ trillion deficit expected in 2009, China and other surplus countries are rightfully asking themselves whether they want to increase their exposure to the US economy. This reticence to buy US debt could lead to a rise in treasury rates, particularly as the stimulative actions of the Obama administration begin to take hold.