Headlines mislead on Chinese bond purchases

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Article Highlights

  • Treasury estimates are misleading

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  • Chinese bond purchases are going up, not down

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  • China remains financially dependent on the US

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China holds a large amount of US Treasury bonds and changes in their holdings are often treated as important. Most recently, China's holdings of Treasuries were said to drop almost $50 billion in December. This is seen by some as portending loss of faith in the dollar and perhaps rising US interest rates.

This conventional view is mostly wrong, including the apparent fact that China cut Treasury holdings. Instead, the most important developments are: (1) China continues to accumulate Treasuries, directly and very likely indirectly, and (2) there was a surge in trading of foreign bonds by Chinese entities operating here. The clear implication is that China remains financially dependent on the US.

Start with the $50 billion drop. It occurred at the same time as a $55 billion jump in Belgian holdings, more than 25% in one month. For the year, Belgians supposedly decided to add $118 billion in Treasury holdings, an 85% increase.

This is highly unlikely. What is much more likely is that a chunk of "Belgian" purchases were Chinese. It would not be the first time Beijing has bought through third parties. The motivation is to hide exposure to the American bond market from a population that resents money being sent overseas.

The monthly series on Treasuries holdings is at best inadequate to portray the true state of Chinese securities activity in the US and at worst outright misleading. It is necessary to check two other sources, the transactions record and more comprehensive data on foreign holdings of US securities, the preliminary version of which was published Friday afternoon.

The transaction record shows one clear development - in mid-2013, the US became a place for Chinese entities to trade foreign bonds. Trading volume exploded from $12.4 billion in 2012 to almost $207 billion last year.

Chinese financials have become bigger and more mature participants in international finance. What has not matured, however, is China's own financial system. In particular, Chinese capital controls makes bond trading more difficult. So the US becomes a place to do this.

The same logic applies to China's Treasuries holdings. Stark limitations on the movement of capital in and out of the country prevent Beijing from spending its huge pile of foreign exchange at home. The only place that can absorb it is the American bond market. China's financial weakness brings this activity to the US as well.

There is further evidence in the more comprehensive documentation of foreign holdings of American securities, which is complete through June 2013. The preliminary numbers show China slightly behind Japan as the largest foreign holder, at $1.74 trillion.

China's total is about $145 billion more than it was in June 2012. And $135 billion of the increase is due to additional purchases of long-term Treasuries, which hit almost $1.27 trillion.

Moreover, these figures underestimate China's holdings. The third and fifth largest investors in US securities are the Cayman Islands and Luxembourg, tiny in terms of size but major off-shore financial centers. Their holdings rose $290 billion from June 2012 to June 2013.

China is hardly the only candidate for investment through off-shore centers, but it is perhaps the main one. It would be no surprise if $50 billion of the purchases of US securities from off-shore centers was due to China. Along with the direct buys and likely purchases through Belgium, Chinese holdings of American securities probably rose by close to $200 billion from June 2012 to 2013.

This was and continues to be unavoidable. China's balance of payments surplus exceeded $500 billion in 2013. The money has to go somewhere. Until Beijing changes its rules limiting the movement of capital, it has no choice but to put hundreds of billions into the US, the one set of markets big enough.

That makes the situation simple for American policy makers. First, do not be fooled by monthly changes in Treasuries holdings attributed to China. Second, watch instead for much bigger, unmistakable changes in Chinese policy or in the balance of payments. Third, if you do not want Beijing to own too much American debt, the only thing to do is stop borrowing.

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Derek M.
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