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China’s investment in U.S. Treasury securities is largely because of its exchange rate policy to limit the yuan appreciation against the dollar and the fact that holding the U.S. dollar does not earn any interest. Federal Reserve monetary policy expectations in relation to the dollar may have contributed to China’s foreign exchange arrangement of holding U.S. Treasury securities rather than U.S. dollars. The second graph depicts the Chinese yuan depreciation against the U.S. dollar and the Chinese holdings.


China’s foreign exchange rate reserves have increased sharply in recent year in terms of their holdings of U.S. Treasuries.















In order to understand the impact of the China’s exchange rate policies in relation to their holdings of U.S. Treasuries, a 6-month and 18-month exponential moving average was used to form China’s holding of U.S. Treasuries moving average convergence-divergence (MACD). The last graph presents MACD for U.S. Treasuries purchased by China and the yuan/U.S. dollar exchange rate.


It can be observed that in July 2005 the rate the yuan depreciated relative to the U.S. dollar increases, consequently the Chinese holding increases significantly, while the net exports for goods increased marginally. Quarter-on-quarter, the underlying data for the Chinese holding of U.S. Treasury securities points to a 23% increase, while the net exports for goods increase was just 1%. A similar pattern can be noticed in Jun 2006 and July 2007, where an increase in the holding rate was accompanied by decisive exchange rate depreciation while net exports increased marginally.


After September 2008, during the recent financial crisis, the trade deficit and the purchase of U.S. Treasury securities are highly decorrelated. The last graph indicates a high rate of increase of U.S. Treasuries purchased by China beginning with this phase. Was this acceleration in U.S. Treasuries purchasing designed to finance the United States government substantial level of borrowing or was it China’s exchange rate policy to limit yuan depreciation in response to Federal Reserve monetary policies?


Many economists will argue that China’s holdings of U.S. Treasuries will not be substantially impacted by yuan appreciation. However, the historical data shows that China’s exchange rate policy was complemented by China’s ownership of U.S. Treasury securities, more than some economists will admit.


The gradual appreciations of the Chinese yuan against the U.S. dollar will have an impact on the rate of Chinese purchase new U.S. Treasury debt. The potential impact to the U.S. economy of the new direction of the Chinese exchange rate policies deserves a separate topic.

Yuan Appreciation - Implications for China’s U.S. Treasury holdings

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Many commentators expect the appreciation of the yuan to force China to invest more in US Treasury bonds. I believe it will have the opposite effect as their past investment motives have not been fully understood.


The People’s Bank of China decision to shift to a flexible exchange rate may set the expectation that China may have to buy less U.S. Treasury securities. Brian Coulton, head of Global Economics at Fitch ratings, pronounced that yuan appreciation will compel China to invest in U.S. Treasuries in large part because of flows of foreign investment into China. These speculations ignore the fact that China is the major foreign purchaser of U.S. Treasuries because of its exchange rate policy. This report examines the importance of China’s central bank exchange rate policies to the purchase of U.S. Treasuries.


China’s central bank is the major foreign purchaser of U.S. Treasury securities. The Chinese investment in such securities can be viewed as being in China’s economic interest for the following reasons. First, China’s increase in holding of U.S. securities may be regarded as China financing the U.S. trade deficit. Since the U.S. consumes more than it saves it depends on foreign investment for its needs. The first graph indicates China’s holding of U.S. debt represented by China’s holding of U.S. Treasury securities and the U.S. trade deficit abstractedly represented by net exports of goods. It can be observed that there is not a direct correlation between the trade deficit and debt holding beginning with 2005.

  













Some economists argue that China’s increase in holding U.S. Treasuries helps the U.S. Federal government pay for its financial stimulus packages and is an endorsement of U.S. economic policies. The article "China Backs Obama as Treasury Holdings Rise to $900 Billion" that appeared on Bloomberg supports this argument.


Second, China emerging as a central player in global trades should be a concern if any major actions destabilize global economies. The global financial crisis may have forced China to continue to invest in U.S. securities. A sudden fall in U.S. Treasury securities purchase, if it occurs, not only will slow U.S. economic growth but will depress U.S. imports from other major partners that in turn could slow their economies. Correspondingly this could weaken the global appetite for Chinese products.
















By GIGEL MARINESCU