Month after month, China’s holdings of US Treasury securities are eroding. In other words, the central bank of this country lends less and less money to the American federal government. What’s going on? Should we be outraged? Should we even be worried?
The mainstream financial press noted this gradual trickle of Chinese ownership of these bonds, but did not sound the alarm. Marginal media, especially those based on the Internet, see more perils here.
Readers ask, “Is Biden causing foreign governments to lose faith in US bonds?” In the dollar itself? Or, “Is this another twisted maneuver by the Chinese government to manipulate the value of its currency in order to deceive us?”
The quick answers to these concerns are “no” and “no”.
But before explaining why, in a future column, we must lay the groundwork by explaining why other countries, such as China, Russia, Ukraine, Somalia or Peru, maintain stocks of US dollars, often in the form of US Treasury bonds. obligations. In addition, private companies in many countries, whether manufacturing, trading or financial, often choose to hold large balances in US dollars, euros, yen, pounds sterling or Swiss francs. Some hold Chinese renminbi, also known as yuan. Why?
The answer is that for those who are not in one of the world’s dominant economies, those whose silver is widely used as a “reserve currency”, it is wise to maintain stocks of these currencies. Your country needs it to pay for imports and to pay interest and principal on any money you owe to other countries that is not denominated in your own currency.
You accumulate these foreign currencies when you export goods and services or when companies or financial companies from other countries invest in yours. This can be done by building factories and shops or by buying stocks or bonds traded in your financial markets.
You spend these foreign currencies when you pay for imports of raw materials or manufactured goods or services. As noted, your country pays the interest and principal due on loans obtained abroad. This can be ‘sovereign debt’, borrowed by your government, or private debt from companies in your country that have financed a project by borrowing on international markets.
It is wise to have widely traded major currency reserves to meet these foreign payment needs over long periods of time. Emergencies arise, circumstances change, and a country without adequate foreign exchange reserves can find itself in serious trouble. This is currently happening in many developing countries, particularly in East Africa.
Over the past year, the actions of major oil producers combined with Russia’s attack on Ukraine have more than doubled oil prices. Within months, some poor oil-importing countries used most of their foreign currency to pay for fuel. Now it’s hard to go on. Unfortunately, food prices have also risen. These countries can no longer pay for imports of basic products such as wheat and cooking oil.
It is therefore not uncommon to see conservatively managed nations maintain a one to two year supply of foreign currency. Irrespective of the usual source of imports, these reserves are kept in easily negotiable currencies such as the dollar, the euro, the pound, the franc or the yen. Neither Kenya nor Ukraine of course use the US dollar or the Euro as their national currency, but when Kenya buys wheat and sunflower oil from Ukraine, the transaction is done in one of these currencies. So every nation has some in reserves.
The exchange rate, or relative values, of a nation’s own currency against major international currencies is always crucial. And yes, a nation can manipulate the value of its currency to gain a trade advantage.
Unfortunately, the terms “weak” and “strong” are used to describe a currency at a given exchange rate. “Cheap” and “expensive” would be better. If a country’s currency is cheap, its exportable goods are cheap to overseas buyers and more will be sold. But domestic producers will still get the price in their own currency.
When the United States repudiated Bretton Woods’ system of fixed exchange rates after World War II in 1972, the dollar became “cheaper” in world markets, as did U.S. exports of corn, wheat, soybeans, pigs, bulldozers, locomotives and airplanes. It was the dawn of a new era in agriculture and manufacturing in the United States.
But just a decade later, large budget deficits under the Reagan administration and the Federal Reserve’s tight monetary policy drove the value of the dollar up. American crops have become expensive abroad while steel and automobiles imported here from other countries have fallen in price for American buyers. It was the “agricultural crisis” of the 1980s and the rapid deindustrialization of the “rust belt”. And the economic pain was deep and widespread.
Neither the deficits nor the high interest rates resulted from planned policy by Congress or the Fed. But fast-growing countries, such as Japan, Taiwan and South Korea from the 1950s to the 1980s, acted to keep their currencies as cheap or “weak” as possible in order to promote exports and discourage imports. without resorting to customs duties. After 1978, China did the same.
To keep currency cheap, you need to offer lots at a low foreign currency price. You do this by greedily buying foreign currency. You do this by creating more of your own currency. Thus, taken alone, it could cause inflation. But there are ways to handle this, at least up to a point. Obviously, when you greedily buy dollars, yen or euros, you accumulate stocks of them. What to do? Well, buy bonds paying interest in that currency. For dollars, what’s better than US Treasuries?
This export promotion process has brought China to the point of possessing some $3.5 trillion in foreign currency. In recent years, this has typically included about $1.1 trillion in US Treasuries of various maturities. It was the last so high in December 2019.
In the 12 months from June 2021 to June 2022, China’s holdings of US Treasuries fell from $1.062 billion to $968 billion, a drop of about 10%. This should make the renminbi more expensive in the foreign exchange markets, discourage exports and stimulate imports. It is therefore not a question of manipulating the American-Chinese trade to the obvious advantage of this nation.
So what’s up? That has to wait for a future column.
St. Paul economist and writer Edward Lotterman can be reached at [email protected]