Why won't China reduce its exposure to US dollars after all this talk of decoupling?

Question

As Treasury yields soar, however, that thinking may be changing - the two-year is up 50 basis points this month and close to November's 15-year high of 4.88%, while the 10-year is up 40 basis points this month and knocking on the door of 4%.

China's appetite for T-bills, meanwhile, may waver due to the U.S. debt ceiling issue. But overall, it seems like Beijing is prepared to tweak the composition of its dollar assets rather than reduce its exposure to the greenback [US dollars].

https://www.reuters.com/markets/asia/china-slips-away-treasuries-sticks-with-dollar-bonds-2023-02-22/

Why won't China reduce its exposure to US dollars after all this talk of decoupling? It seems like China holds as many dollars as before, except it doesn't hold as much U.S. Treasuries as before opting for higher yield bonds with slightly more risk. Is there a reason why China can't decouple and sell more of its dollar holdings?

Answer 1

Question:

Why won't China reduce its exposure to the greenback after all this talk of decoupling?

Short Answer

Decoupling? Their entire economy is based on exports. If they fix that then we'll talk decoupling.

Why don't they diversify their reserves away from the US Dollar. Because they can't. Their ideologues really want too, but it's very hard to do when you are holding trillions of greenbacks and accumulating more every year.

Answer

The US is China's largest trading partner. In 2022 U.S market accounted for 16.2% of all of China's exports($583 Billion). This huge surplus in trade China runs with the US is a double sided sword for both countries. It means they are flooded with all this U.S. money annually in greenbacks.

Typically in a more balanced trade relationship China would turn around and purchase U.S. products with that money. For various reasons, they aren't spending those dollars but holding onto them. Really doesn't matter.

So here is the problem in trying to dispose of them. No one in the world will value US dollars more than the U.S. So in order to receive full value China or anyone china might transfer those dollars too must spend them in the U.S. They can buy companies, real-estate, US-bonds, or products. It all works to the U.S.'s benefit.

Yes in economics short turn uncertainty is a huge problem, and Yes China could dump massive US dollars on the market at a huge loss to themselves and cause some problems for the U.S that way. The value of the dollar would fall, making U.S imports more expensive and U.S. exports cheaper. This is a bit like stabbing your opponent through your own chest.

It would be a short term problem for the U.S. it would be a catastrophe for China. Such a move would cost them a significant percentage of the value of those dollars; still let's go with that for a moment. Whoever purchased the dollars from China likely at a huge savings, would still be faced with the same problem. In order to get full value for those dollars they would still have to repatriate them to the U.S. It would be like taking a blow torch to a sizeable percentage of your countries hard currency reserves. Let's also not forget China's total municipal and national debt is like 250% of GDP. They're not in any position to be bond firing their reserves. Something I'm certain their economists are explaining to their ideologs.

As long as China favors an export driven economy, they will have a hard time moving away from the greenback. This and their proclivity to hoard dollars work against any such move. If they did decide to responsible dispose of dollars, That's even better for the U.S. Buy lots of stuff the U.S. has to sell, great. Of coarse they still have that 16% of their exports come to the US and are paid for by dollars.. eliminating the trade deficit also works for the US, and would certainly reduce China's exposure to the greenback. That would be great too for everybody, that's how trade is supposed to work.

Answer 2

Possibly one of the reasons is that they're not too worried about any potential Western sanctions in that regard, having more than enough room to retaliate, according to one analysis (published by the Atlantic Council think tank):

China has about $3.4 trillion of identifiable international assets at risk of possible sanctions and up to $5.8 trillion of liabilities to, or assets in China of, international investors and companies largely from Western countries. China therefore has plenty of room to take retaliatory actions. A sanctions and counter sanctions war game suggests that the losses are comparably severe for both sides.

BTW, it's quite hard to find factual data on the composition of the PBC FX reserves. They only publish a dollar equivalent of their overall reserves, but not any breakdowns (by currency etc.) There's only some pretty old official data...

in a 2018 report, China’s State Administration of Foreign Exchanges (SAFE) indicated that the USD share of its assets declined from 79% in 2005 to 58% in 2014, presumably falling further since then.

Also, those are hardly the only reserves China has. It's been long suspected that they shift reserves to other state banks, so that in effect they'd be about double what the central bank declares/has.

And if were talking about bond sale only, China has also been selling its own debt to US investors, as WSJ noted in 2021:

This would be the fifth year in a row that China has raised billions of dollars with a fall sale of debt in the international bond markets. The ministry previously said that it would issue $4 billion of bonds [...]

[...] Last fall, China issued $6 billion of dollar bonds, with five to 30-year maturities. It also sold the equivalent of about $4.7 billion of bonds in euros, including its first negative-yielding debt.

Like last year’s dollar bonds, this year’s will be sold in both a 144a format, which allows debt to be sold to investors in the U.S., as well as under the less onerous Regulation-S framework for international debt sales, the notice to investors showed.

That's not really decoupling (that China is looking after).