Will China Stop Buying U.S. Government Debt?

The major financial headline on Wednesday morning of January 10, 2018 was a report that Chinese officials are considering slowing or stopping its purchases of U.S. government debt.  This news sent bond yields higher.

It did not stay in the headlines for long though because the establishment media doesn’t  want to contemplate what might happen if the Chinese were to actually sell off U.S. debt.

China is currently the number one holder of U.S. debt (not including the Federal Reserve).  Japan comes in a close second.  As of October 2017 (the latest figures available as of this writing), China held about  $1.189 trillion.  Japan held $1.094 trillion.  In a distant third place was Ireland with $312 billion.

In October 2016, China held about $1.116 trillion, and Japan held $1.132.  In other words, there were brief periods where Japan actually took over the top spot.  Over the course of a year, China has increased its holdings a little, while Japan has decreased its holdings a little.  When I use the term “little”, it is in context with the total numbers.

Overall foreign holdings of U.S. Treasury securities increased from $6.044 trillion to $6.349 trillion.

Interestingly, Russia actually increased its holdings from about $75 billion to $105 billion, despite the anti-Russia sentiment coming out of the U.S.  Maybe the Russian government and central bank thought it could trust Trump more to regain good economic relations.

So what should we make of this report that Chinese officials are recommending a reduction in buying?

First, by looking at the numbers, the Chinese central bank has not been a big buyer lately anyway, at least in context with its total holdings.  A slowdown in buying has been expected for a long time now, and it has already been happening.  The Chinese are increasing their gold holdings faster than their U.S. Treasury holdings, at least on a percentage basis.

The biggest question that I don’t see answered out there is whether the Chinese would actually stop rolling over maturing debt.  This is how the Federal Reserve is very slowly reducing its balance sheet.  It is technically not selling any debt.  It just isn’t rolling over some of the maturing debt.

If China actually stopped rolling over existing debt, this would be big news.  Then we would start to see a reduction in its holdings.  But if it keeps rolling over maturing debt and maintaining a steady holding of U.S. Treasuries in the neighborhood of $1.1 trillion or $1.2 trillion, then this isn’t that significant of news.

I highly doubt the Chinese are about to drain off their holdings of U.S. debt.  The reason is that the top officials are mercantilists.  They believe that they need to keep U.S. Treasuries in order to help its exporters.  They do not want a strong yuan that would hurt exports, even though it would help over one billion consumers inside of China.

However, I do think that much of the rest of the world is getting tired of the U.S. government calling all of the shots when it comes to foreign policy and economic policy.  This is why many countries are finding alternatives to the dollar for foreign trade.  They aren’t outright abandoning the dollar, but there is no reason that people in China cannot trade directly with people in Russia without the use of U.S. dollars as a middleman.

U.S. consumers have long been subsidized by the fact that the U.S. dollar is the world’s reserve currency.  U.S. consumers are also subsidized by the Chinese government for propping up China’s export industry.  The Chinese ship products over to the U.S., and they use the U.S. dollars to buy U.S. government debt.  This is just stupidity on the part of Chinese officials, so it is no surprise that they are considering at least a reduction in this policy.

Unfortunately, the Chinese, in the process, are also subsidizing the politicians in Washington DC, along with the Federal Reserve.  When Chinese central bankers buy U.S. government debt, this means that the Fed does not have to buy as much, or interest rates are lower than they otherwise would have been.

For this reason, I hope the Chinese do stop buying U.S. government debt.  I hope they start selling.  It may hurt the U.S. consumer in the short run, but it will also hurt the spending politicians in Washington DC.  It will help to drive up interest rates and finally put pressure on Congress to spend less.  Nothing else has worked.  In order to see any serious cuts in spending, we need higher interest rates and a higher threat of price inflation.

And we drastically need lower spending coming out of Washington DC, as our living standards have taken a massive hit from the resources being consumed.  While most everyone focuses on tax rates, the real focus should be on total government spending.  All government spending is a consumption of resources, and those resources have to come from somewhere.  Whether you pay through the income tax or inflation or debt, it is still ultimately coming out of our pockets (unless the Chinese want to pay for it indefinitely).

In conclusion, I don’t take the news of China reducing its purchases too seriously.  If China actually starts to significantly reduce its overall holdings of U.S. debt, then we should pay closer attention.  It will ultimately be painful, but it would be better for the long run if interest  rates are forced higher and the Congress is forced to cut spending.

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