Why does Beijing hold US government debt?
The eagle-eyed amongst you will have noticed some tension emerging between the US and its largest trading partners, particularly China. Global markets have been hooked on tariff-related news for the last six months, but one area that hasn’t received much attention is the stash of US Treasuries held by China, and, specifically, how Beijing might act should tensions escalate further. China holds a huge amount of US Treasuries, which it could dump in the marketplace and create havoc with long-term interest rates, mortgage rates and the stock market. But why does China hold such a quantity of US government debt in the first place, and how likely is it that Beijing would try to disrupt markets in this way?
It is true that China holds a lot of US Treasuries. The US Treasury estimates that China owned about $770bn worth at the end of 2024, which is an awful lot, about the same amount as British investors, although not as much as Japan, which owns over $1,170bn. As the chart below shows, China’s Treasury holdings were mostly built up in the noughties.
The mechanism that led to China buying Treasuries was simple. In order to stop the Renminbi rising too much against the US dollar, and making Chinese exports more expensive, the People’s Bank of China (PBOC) sold Renminbi and bought dollars in the foreign exchange markets. If executed in large enough quantities, the dollar would go up and the Renminbi would fall, keeping Chinese exports cheap in overseas markets.
There were two clear side effects of this action. The PBOC sold Renminbi as freshly printed currency, a bit like our own Quantitative Easing programme from a few years ago. Printing lots of a new currency tends to be inflationary, and in the noughties China experienced an inflation problem.
The other side effect of the intervention was that the PBOC built up a stock of US dollars which it had to do something with. Central bankers are cautious by nature, and so the PBOC started buying US treasuries which are deemed to be ‘risk free’. The PBOC bought a lot of Treasuries in a relatively short period and briefly became the single biggest holder of Treasuries in 2011.
By the mid-2010s, the Renminbi started to weaken, prompting the PBOC to intervene in the foreign exchange markets once more. So, the PBOC sold Treasuries and used the cash to buy Renminbi. Also around this time, in 2016, President Trump was elected for the first time and anything China-related became much more politicised. For this, and other good diversification reasons, the PBOC began to allocate its reserves into other currencies, like the euro, the Japanese yen, the Australian dollar, and even gold. The PBOC used to have more than 80% of its reserves in US dollars. Over the last decade, this has been diluted to about 55% and could decline further, not necessarily because the PBOC is selling US Treasuries, but because it is using new money to buy other currencies.
The effect of dilution cuts both ways. China used to own nearly 9% of outstanding US Treasuries in 2011, but since then the US has been very accommodative and issued a great deal more Treasuries to finance its deficit. Simply by diversifying new money away from Treasuries, China’s share of the outstanding total has dropped to about 2.7% today. This undoubtedly reduces the political prominence of the holding.
Selling its US Treasuries would remove one of the PBOC’s most useful sources of rainy-day money. One of the central bank’s main functions is ’maintaining the Renminbi exchange rate at an adaptive and equilibrium level.’ The PBOC would not be able to do this without deep reserves of easily saleable US Treasuries. It has gold and other investments but none of these are as liquid as a US Treasury.
One of the reasons why China might need rainy-day money is to support the Renminbi at times of stress. A currency that is ‘adaptive’ and at an ‘equilibrium level’ allows its exporters and importers to plan ahead. Too high and exporters cannot flourish, too low and imported raw-material prices rise, causing inflation. Having a healthy stock of US dollar-denominated government debt enables the PBOC to smooth the path of the Renminbi in the currency market. Selling all China’s US investments, and bringing home the proceeds, would probably push the Renminbi up out of its path and hurt Chinese exporters.
The Chinese authorities do not seem to be prepared to sell their US Treasuries despite worsening US relations. The central bankers at the PBOC are conservative people, and such a large sale would inevitably lead to the realisation of significant losses on China’s portfolio of Treasuries, something no bureaucrat in the world would contemplate without strong political direction and a clear safety net.
In summary, the substantial stock of Chinese-owned US Treasuries is primarily a result of the PBOC intervening to prevent excessive appreciation of the Renminbi. With the bulk acquired over a decade ago, this has largely been maintained since. Given the US dollar’s status as a major global currency, China’s holdings of US Treasuries are essential for stabilising the Renminbi and promoting economic growth without causing inflation. Ultimately, China’s self-interest indicates that it will retain its Treasuries, a decision that is likely to suit both countries for now.
Looking ahead, the dynamics of global trade and geopolitical tensions could influence China’s strategy. Any significant shifts in US monetary policy, economic sanctions, or changes in global financial markets might prompt China to reassess its position. Additionally, the development of alternative global currencies or financial instruments could impact the reliance on US Treasuries. Therefore, while the current strategy serves both countries well, future economic and political developments will be crucial in shaping the long-term outlook.
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