China’s Step Back From the U.S. Dollar Is Just One Sign of Rising Tensions

Despite this, tensions have started to rise again after China started cutting ties with a record number of U.S. treasuries, with these agency debt bonds worth $53.3 billion. The reason could be Donald Trump potentially becoming U.S. President again. 

Treasuries make up a large proportion of U.S. sovereign debt, which are extremely low-risk as the government can raise taxes or increase revenue to make payments. In short, China is decreasing the amount it is investing into American debt.

Investors and economists are now trying to examine what is happening in China a bit more closely to attempt to figure out what will happen next and whether it is just temporary or if it will have a deeper impact on the rest of the world.

However, in the first quarter of 2024, China’s stash of U.S. treasuries and agency bonds fell to just under $40 billion and $10 billion, respectively. 

The People’s Bank of China has said it will add treasury bond trading to its monetary policy arsenal. The dilemma China faces is essentially meeting ambitious growth targets while maintaining financial stability as debt has bolstered the country’s growth.

These are important to central banks in order to buffer your domestic currency against the political shifts and economic shocks. China’s dropping of US foreign exchange reserves essentially means that they are not using as many US dollars to bolster the Chinese Yuan.

As China and Japan sit on different ends of the global geopolitical spectrum, these numbers are significant. There is still some confusion as to why China’s number has gone down so much. While it could be because the country is losing money, it could also be because it has decided not to reinvest these bonds. 

Current issues between the two countries include China’s subsidized production of renewable energy infrastructure (such as electric vehicles, solar products, and lithium-ion batteries), protection against money laundering, and financial stability in the event of a bank failure. The two countries’ intentions towards trading with Taiwan has been particularly volatile.

Since that comment was made, the U.S House has passed $550 million in military aid to Taiwan. With speculations around conflict between China and the U.S. through Taiwan, is it any wonder that China is cutting economic ties?

This has been seen as a strategic tactic by China, and while it could potentially benefit China in the long run, the results for the U.S. could be catastrophic.

FX Street reported that the People’s Bank of China has added over 300 tons of gold to its reserves since October 2022. As opposed to debt securities where one party might not follow through on their side of the agreement, gold has virtually no counterparty risk.

This has been the situation for Chinese bonds since China was included in global indices. The SSGA’s shareholder stated: “The board do not believe that [the yields] will increase materially in the near future and the fund is uneconomic to operate.”

Should a situation arise in the U.S., China will be expected to help them due to its financial interests. By spreading these assets across other countries worldwide, it minimizes the effect of geopolitics on them. 

Then there is the issue of interest rates. Everyone wants to make the most of their money, which they can do when interest rates are high. But if interest rates are low, they don’t make much back in return, so they tend to look elsewhere for higher interest rates.

However, some, particularly on Wall Street, have argued that these deals aren’t in the best interests of these countries. This is especially true as countries in the West have been the leading force when it comes to these debts for many years.

Ghana is yet to finalize an official debt-restructuring agreement with China but the trend seems to point to China extending payment periods on countries’ debts without reducing the principal amount owed.

Foreign investors account for around a third of U.S. treasuries and 35% of all domestically held U.S. treasuries are called by the Federal Reserve Bank, which is currently out of the market.

These countries are Brazil, Russia, India and South Africa. They have all been doing this to diversify their reserves and reduce their dependence on the U.S. dollar.

Belgium is often custodian to China’s debt holdings and is reported to have disposed of more than $20 billion of treasuries in the first quarter of this year. On the other hand, this may just be the routine debt re-management of an economic powerhouse.

By the end of 2023, the U.S. debt stood at $34.4 trillion. Due to this figure, countries that have financial interests in the U.S. want to pull out so they don’t get caught up in this debt.

Other Chinese-made products subject to higher tariffs include advanced batteries, solar cells, steel, aluminum and medical equipment. 

The yuan is currently trading at a seven-month low against the dollar. The yuan has depreciated by 0.2% against the dollar this month and 2.1% overall this year. Alongside yield gaps compared to US government bonds, China has monetary issues in its own backyard.

However, there is likely no need to panic. As the combined holdings of Europe and Japan are bigger than China’s, there is hope that the impact won’t be too big on the U.S. and that everything can carry on as somewhat normal.

Alternative countries may be South Korea and India, and perhaps Australia, given that revenue has been has held up well. Whether this would replace Chinese investment does not seem likely due to the lack of market scale.