It’s a marvellously pejorative term, isn’t it: American debt? However, in reality the funds in question, held by China, do not really imply a debt (as in this case: America owes China the money), rather it reflects the fact that the Chinese invested in US government bonds to give them a return on investment and a hedge against a rising US currency; however a government bond is so close in nature to a loan that the term is often used. So, just like any other investment vehicle, the Chinese have decided that it is time to adjust their portfolio somewhat. What might be the reasons underlying this decision?
The Chinese hold $1.173 trillion worth of US government treasury bonds, making it the largest holder of US debt in foreign hands. China holds slightly more than a third of all US debt held in foreign nations. Slightly more than half of all US debt is held domestically through US investors (for example as part of pension holdings etc).
In August, ratings agency Standard and Poor’s downgraded their evaluation of American credit from AAA to AA+ (still a pretty good rating), partially because of US sovereign debt and due to a lack of bi-partisan accord to get the US borrowing ceiling raised. Over the last two years, China has eclipsed Japan as the world’s second largest economy behind the USA. China has led (some might say single-handedly) the world out of the global recession and it currently seeing growth above the 9% mark.
2012 will be an election year in the USA. Many analysts and politicians have questioned whether China’s success has been because the Yuan is being kept artificially low to maintain the competitive edge in importing markets and as the election nears, the rhetoric and (probably empty) promises related to US-Sino trade and currency matters is only set to increase.
The Chinese have recently sold off $36.5 billion of its holdings in US Treasury bonds since August, according to data just released by the US Treasury. The move increases liquidity in China to deal with domestic problems, such as its own internal public debt crisis. However, market watchers will be keeping a close eye on future developments. A substantial sell off of Chinese held Treasury bills could lead to their substantial devaluation in the markets.