More Incoherent Remarks From China on Its Dollar Holdings

Dean Baker has regularly made fun of the idea that the Chinese are concerned that they will show losses on their large dollar positions, mainly in invested mainly in US Treasuries. As serious traders will tell you, it’s actually easy to manipulate a market, but hard to make money doing it. As Baker put it:

The argument that China is worried that it will lose money on its dollar holding because of a fall in the value of the dollar implies that the Chinese are morons. There can be no doubt that the dollar will fall and that the Chinese will lose money on their dollar holdings. The only thing that keeps the dollar from falling now is the decision by the Chinese government to buys hundreds of billions of dollars a year. Of course China can keep the dollar from ever falling as long as it is prepared to buy ever more dollars, just as it could have kept shares of at $100 if it continually bought more shares. (By the way, the dollar will fall because of our trade deficit, not the budget deficit. If we had the same trade deficit and the budget was in surplus by $1 trillion a year, the dollar would still fall.)

The only plausible story for China’s buying of vast amounts of dollars is to support its export market to the United States. It could do much better investing its surplus in euros, yen, or almost any other currency in the world or just about any commodity. China knows it will take a bath, arguing otherwise is saying that the Chinese leadership is stupid.

Yves here. Um, an article at Bloomberg tonight suggests that the Chinese are stupid, or maybe crazy like foxes. If they can convince us to buy this barmy argument, that their certain losses on their currency manipulation are somehow our problem, then they can extract some completely unwarranted concessions from us.

From Bloomberg:

U.S. Treasuries fail to provide safety or liquidity when it comes to managing China’s $2.45 trillion foreign-exchange reserves, said Yu Yongding, a former central bank adviser.

“I do not think U.S. Treasuries are safe in the medium- and long-run,” Yu, a member of the state-backed Chinese Academy of Social Sciences, wrote yesterday in an e-mailed response to questions. China is unable to sell the securities in a “big way” and a “scary trajectory” of budget deficits and a growing supply of U.S. dollars put their value at risk, he said….

“China has to depend more on demand and supply in the foreign exchange market for the determination of the yuan exchange rate,” Yu wrote. “Only God knows how much value that China has stored in the U.S. government securities will be left in the future when China needs to run down its reserves.”

Yves here. Let’s be clear. These holdings were accumulated as part of a trade policy. Currencies of developing countries generally rise as they become more prosperous. China has deliberately kept the value of its currency artificially cheap by buying dollars. Losses were inevitable, so the Chinese caviling is misguided.

Yu’s comment about the illiquidity of China’s Treasury position is accurate but equally wrongheaded. Take a big enough position in ANY instrument, no matter how actively it is traded, and you will not be able to exit your position quickly without depressing the market, as LTCM learned painfully when its interest rate swap bets constituted 10% of the market and it desperately wanted to reduce them.

But expect this sort of thing to come up with increasing frequency as frictions between the US and China rise. Unfortunately, enough people in both countries seem to buy into this faulty argument to assure it a continued hearing.

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  1. Kirk

    I thought china is holding the US bond number steady and strictly accumulating liquid or very hard asset? They are holding it at under $1T, despite adding forex reserve almost at $.6T/year.

    (couldn’t find better chart, but illustrate just as good)

    China also sign construction contract loan worth tens of billions everywhere. ($20B argentina, $40B iran, $10B pak, $20B venezuela, $1B a pop all over africa) They are able to recycle dollar all over the world very quickly, faster than Ben can print that funny money. (I wonder if they give up and decide to pump DOW instead. much cheaper. now there is a place to burn dollar quickly.)


    btw, one version of calculation predicts China economy in USD GDP will reach parity at around 2019, far earlier than 2025 number from a decade ago. (8% annual growth, vs 3%, and .5 yuan appreciation/year or so.)

  2. bob

    Fade China.

    “I do not think U.S. Treasuries are safe in the medium- and long-run,”

    We were so upset that we got stuck with long dated government and agency debt that we demanded US monetary policy be changed so we could sell all of our long dated debt and convert it to short term debt.

    The bankers on Wall st recommended this to us. They are doing very well, so we should too.

  3. scharfy

    Spot on.

    China acquires dollars because they sell us things.

    They could immediately refuse to accept dollars. That’s what people do who don’t like dollars, they stop accepting them.

    Or if they accumulated them and wanted to trade them in, they could immediately buy Euro’s, Oil, Yen, Gold, or Swatch Watches. But that would take them off their currency peg, and make their products less affordable. So they plunk the dollars into interest bearing bonds.

    The bottom line is that China’s “terrible dollar holdings” (treasuries) have been an great investment over the last ten years.

    If/When the trade imbalance is rectified, their dollar holdings will be reduced.

  4. traderjoe

    @Yves – Interesting perspective on the article. But I would note that the Chinese author Bloomberg is quoting is discussing the safety of the UST’s, not of the dollar exchange rate per se, and perhaps even addresses the desire to let the RMB float more (though I think that’s a total ruse).

    I realize in your MMT world you can issue as much money/credit without interest, but in the privately-held FRN/UST world I do believe there is a limit to our ability to both issue and service the debt. So, to make my comment brief, IMHO what he is talking about isn’t incoherent. With a very broken political and economic system, debt outracing capacity across sectors (private, muni, UST), there seems a very real possibility that there will be a debt crisis soon. Of course, the Fed will support the debt through outright purchases and through the PD’s and the yield curve carry. But, market confidence can be lost quickly, taking out the marginal buyer.

    I also believe that China may sometime in the future decide to dump UST’s as a precursor to it’s ascendency to super-power status, to back the creation of an alternative reserve currency, etc.

    So, I listen to the comments about the strength of the UST, as at least having some validity, and also as a signal about the intentions of a large buyer of the paper.

  5. charles 2

    The losses on their dollar asset is the fair compensation of the intellectual property that is effectively stolen through systematic copying of foreign products and processes (instead of outright buying).

  6. Costard


    Mr. Yongding is disembling… there are some things which cannot be said in China. For instance: that UST purchases have skewed the exchange rate; that China’s massive holdings cannot be redeemed at the current rate; and that because of this the PBC, whose liabilities are in yuan, is in reality insolvent.

    Treasuries will last as long as the dollar, and it is pretty nutty to talk about default at this point. It will happen to us, most assuredly – MMT be damned – but that’s in the future and China’s concerns are much more immediate. Bottom line, when the exchange rate corrects, China will take a tremendous hair cut on its reserves and the fallout will be considerable. Not to mention the other effects of a stronger yuan. Selling the reserves will precipitate this cascade. They only way they can keep it from happening is by continuing their accumulation.

    The tiger is, in reality, paper. China has no more control at this point than do we.

    1. attempter

      …it is pretty nutty to talk about default at this point.

      The entire political and media class led by Obama are talking about a partial default, namely claiming the government will be unable to continue paying back the Social Security debt it owes, money it forcibly borrowed from the people on the promise it would be paid back according to a clearly defined contract.

      I’d encourage everyone who cares about the public interest (or for that matter the sanctity of contracts) to join Baker in spreading this “sovereign default” meme, which is both true and could become a market vigilance force in itself.

  7. yoganmahew

    There is a missing link in the circular currency exchange argument, I think. What would China use its forex reserves for? Buying USD denominated goods and services, one supposes. If the cost of those goods and services increases by less than the interest that China is receiving on its USTs, China has gained.

    The book-keeping exercise of translating currencies from one to another is another example of perfidious mark-to-marketism. It is a political exercise that serves a profit and loss account, but doesn’t have an underlying economic justification.

  8. Bruce Krasting

    Great time for bearish remarks from China. The dollar is at a two month low today and looks like it is headed lower still.

    IMHO if we had a budget surplus the dollar would be strong. I do not think it is trade imbalances that are driving the dollar short term. It is the issue of Too much debt and a weak economy.

    The dollar’s value is based on its role as a store of wealth. A month or so ago it was doing a great job at that. But only because the perception was that the US was in a better place than the EU. That has faded now.

    You will never figure out where the dollar goes next by looking at current account numbers. It does not work like that.

  9. Nate

    Good stuff.

    I’ll be interested to see what happens to the Chinese export industry in a weaker dollar/stronger yuan environment. They will be facing thin margins + potentially rising currency + tightening credit + rebellious young labor market + every country in the world seems to want to run a current account surplus right now.

    Most people point to China’s reserves as a strength, ie the Chinese save while the Americans spend. I think if you look at history massive reserves have often led to tears for the reserve-holding company.

    China had ~$2.45T of reserves as of the end of March. World GDP is about $61T. So China’s reserves total about 4% of world GDP. This sort of imbalance has only happened a couple of other times in history, with the US in the late 1920’s right before the Great Depression and Japan in the late 1980’s right before their economy collapsed into a deflationary spiral.

  10. purple

    I’m sure China would like to buy dollar assets other than treasuries but they are prevented from doing so. The US government won’t let them make a takeover bid on Exxon though they have the money to do so. China is herded into the treasuries market due to their weak military position.

  11. BSR

    This argument is silly:

    1. In the course of earning huge trade surpluses, China is becoming an industrial and manufacturing giant (correspondingly, U.S. and other high cost countries are slowly shrinking to midgets). The advantages of such a change in stance outweighs any dollar and cents loss. For e.g. once U.S. loses much of its manufacturing and industrial capacity, it will naturally become a pacifist state since its is hard to fight with “services”. China thus has converted a potential adversary into a peaceful partner (or client state based on political/power perspective)

    2. The huge dollar holdings give China enormous invisible power over U.S. policy. One can say that eventually U.S. government will essentially be remote controlled by Chinese monetary authority just like any old Banana Republic was by U.S. Banks. That they acquired a huge country as a defacto colony at a fairly reasonable money cost and without a drop of blood is an amazing testament to their intellect and forethought.

    1. Deus-DJ

      Mr. BSR,

      If you want to make that argument then you need to make the WHOLE argument, in other words, you must extend it to it’s natural conclusion. But, if you do that, you will realize the folly of having made the argument to begin with. I wish you well.

    2. Deus-DJ

      oh wait lol you were saying that it was silly, you weren’t making the argument yourself? Ok then.

      1. BSR


        My “Silly” observation was with reference to the How-many-angels-on-a-pinhead quality of dollars and cents analysis of China’s policies. First thing first, I don’t have a clue how U.S. will fare as a defacto financial and industrial colony of China. Second, China hasn’t been a capable colonizer (like Great Britain for example), looking for example, at Tibet and Xijiang and possibly, historically, Mongolia.

        All I am saying is that the China trade surplus with U.S. should be analyzed with long horizons similar to East India Company, English/French/Spanish/Portuguese settlement of the New World etc., these events also started as dollars and cents ventures (Spice trade, Opium trade, Tea trade, Gold & silver search etc) but had major consequences.

        Sometime back, when a Roman governor tried a Jewish carpenter for causing social unrest, the results were equally dramatic.

  12. Vangel

    I think that the obvious is missed. The Chinese do not hold much in the way of very long term treasuries and do not need to sell to reduce their positions. To hedge their positions all they have to do is to buy gold, agricultural commodities, base metals, and energy in the futures market, refuse to roll over maturing treasuries, and purchase companies with large amounts of USD denominated debt.

    If the value of their UST holdings goes down their holdings of cash, commodities,and shares will shield the Chinese from the collapse of the American capital markets.

  13. L. Strikes

    see “P R C cant raise interest rates.”
    ‘its (too much world) debt stupid.”
    Why shld countries that once banned ind. ownership
    of p.metals now promote them?

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