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.