Why China Won't Dump U.S. Debt

David Fessler
by David Fessler, Energy & Infrastructure Strategist

Washington's debt-default crisis gave China the perfect opportunity to taunt the U.S. government, and - with the editorial from Beijing suggesting the creation of a "de-Americanized" world - the Chinese sure took it.

Could China bring the United States to its knees without ever setting foot here, just by virtue of its ownership of more than $1.27 trillion in our debt?

No. It's all smoke. Economically, the Chinese are too far in bed with America to get out anytime soon.

The South China Morning Post reported that Beijing continues to add to its U.S. Treasury stockpile. While U.S. data on Treasury purchases since last July isn't available, China's foreign exchange reserves increased by $163 billion in the third quarter, most of it from U.S. Treasury purchases.

No Options

But what are China's options if it wants to sell some of its U.S. debt to diversify its holdings? The short answer: It doesn't have many. Let's look at some of them:

  • Other currencies. No other country besides the United States has enough of its money in circulation to meet China's needs. Further, no other currency is as safe as the U.S. dollar. For example, as the economic crisis of 2008-2009 deepened, countries flocked to the U.S. dollar (in the form of Treasurys) as the only safe-haven investment. The bottom line: Despite the rhetoric in Washington, there is no other country in the world with a currency as safe and as strong as the U.S. dollar.

  • Private-sector bonds. Way too risky for China or any other country. The least risky at this point are those of U.S. companies. So it would really be buying American dollars anyway.

  • Gold. The value of all the gold in the world at current prices ($1,280 an ounce) is $6.6 trillion. Roughly 75% of that is in the form of coins or jewelry, which is not available to governments. There's not enough gold for China to buy.

China's Hooked on Treasurys

In order to keep the value of the Chinese yuan from appreciating versus the dollar, China's central bank must buy U.S. dollars in massive quantities. Rather than just sitting on the physical currency - which pays zero interest - it buys U.S. Treasurys.

Not only will China continue to buy our debt, it must continue to buy it. Its exchange rate policy dictates it. Selling Treasurys would reduce the value of the yuan, something China can't afford.

In other words, we need China to buy our debt to finance our annual federal budget deficit. China needs to buy dollars to prop up its currency.

For better or worse, China and the United States have an incestuous financial relationship that welds the two countries together.

It's in both countries' best interest to see that things stay that way for a long time.

Good investing,

David Fessler

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