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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?

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  • As long as they have a large trade surplus with the US and currency controls that limit the amount of dollars Chines companies can hold, the Chinese state [banks etc.] will have a large amount of dollars. And IIRC, it was mostly the US not China talking about decoupling (although I'm sure there are plenty of Chinese nationalists who talk the same, without thinking of the implications too much). Oct 3, 2023 at 5:22
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    What I'm saying by the latter is that one should not confuse "Made in China 2025" with "We plan to sell nothing to the US 2025". Oct 3, 2023 at 5:34
  • At least back then [2019] when there was the shock of the Trump trade war, China was on a "gold buying spree" cnbc.com/2019/11/18/… Oct 3, 2023 at 6:27
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    Finally, while the Chinese Central Bank total FX reserves are given in dollar [equivalent], their actually holding of dollars is a closely guarded secret. So, most sources just estimate the latter in some way. Oct 3, 2023 at 7:06

2 Answers 2

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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.

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    "As long as China favors an export driven economy" - as long as China favours the US being an import economy dependent on China! The Chinese state attaches an undisclosed but implicit value to ensuring the US real economy is hollowed out, because their Marxist theory declares that value and power originate from the condition of the working class and the physical possession of industry (not the possession of rent or ownership claims upon industry).
    – Steve
    Oct 3, 2023 at 17:08
  • @Steve "As long as China favors the US being an import economy dependent on China!" Yeah no, China isn't the only manufacturing option for the U.S. Many US companies have been leaving China for various reasons for years. It's just business, nothing nefarious. As for the "Real US economy being hollowed out". Highest economic growth in the G7 at nearly 6% last quarter, historically low unemployment, inflation down to below 3% close to the Fed's 2% target, whatever they're doing lets hope they keep doing it.
    – user47010
    Oct 3, 2023 at 17:51
  • @Steve: IIRC around 18% of China's economy (GDP) is directly related to exports. Indirectly, of course, there's more. As for exporting to the US, sure there's some geopolitical aspect to that, but even if they exported nothing to the US, they'd still have to deal with the fact that US denominated transactions dominate other markets too. They'd have to convince all these peoples to pay in yuans etc. Which is no easy task given all restrictions they place on their currency. A recent example reuters.com/world/china/… Oct 3, 2023 at 18:29
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    Essentially you can't have it both ways: tight control over the currency and it becoming much more internationalized. spglobal.com/marketintelligence/en/news-insights/… Oct 3, 2023 at 18:37
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    @Fizz, people will trade in whatever currency demanded by those who have the goods. China does not need to significantly challenge the dollar whilst there is peace - the question is what latent power exists to reconfigure and reorganise when war requires. If you physically have the gun factories and the workers to make them, it doesn't matter that these factories belonged to your enemy. In war, they now belong to you.
    – Steve
    Oct 3, 2023 at 18:49
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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).

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  • China is already under U.S. sanctions. Why would holding trillions in U.S. currency protect them from sanctions? It certainly didn't help save or protect Russia who was also holding trillions of U.S. dollars. Russia's currently down to ($583 Billion) in US currency.
    – user47010
    Oct 3, 2023 at 16:14
  • @JMS, what is the book value of the US's economic dependence on China, and the value of Western assets physically in China but not belonging to China? Provided the Chinese reserves don't exceed Western dependencies and assets, then there isn't so much risk to their holdings, since they are collateralised. I'm also unclear whether China has significant assets physically lodged in the West. With Russia, I think there was less dependency and fewer foreign assets lodged in Russia, whilst the oligarchs had much lodged in the West.
    – Steve
    Oct 3, 2023 at 16:58
  • @Steve, a lot there to unwind. China's reserves exceeding western assets? Don't think that's much of a worry, Total imports from China is 2% of our GDP. Significant assets in the west, both Russia and China do as do their businesses, it's a fact of trade. Yes both China and the US are heavily invested in each other, how could they not be? Nobody is keeping 3.5 trillion under their mattress. The west was hugely dependent upon Russia. about half Europe's coal, and natural gas came from Russia, Russia also was Europe's largest supplier of oil.
    – user47010
    Oct 3, 2023 at 18:09
  • @JMS, GDP is a financial measure, not a measure of possession of real assets and productive forces. We may have been somewhat dependent on Russian energy, but that's a commodity that can be substituted elsewhere. Manufacturing capacity and knowhow isn't a commodity - look at the US's struggles to get their chip fabs back from Taiwan for example. The point is, the Chinese have at least some sympathy with a Marxist analysis, and Marx says labour is the source of value. The Chinese have possession of vast skilled manufacturing labour, something they will reckon somewhere in their calculus.
    – Steve
    Oct 3, 2023 at 18:42
  • @Steve, "Chinese have at least some sympathy with a Marxist analysis, and Marx says labour is the source of value. ", Yeah I don't think they got to be the second largest economy in the world by relying on Marx. As for the rest, China will weather their current economic troubles and remain one of he largest economies in the world. And remain just as dependent on the west and the west is on them, If they screw that up it won't work out better for them. If we screw that up, it won't work out better for us. We are both compeditors and mutually dependent. What's wrong with that.
    – user47010
    Oct 3, 2023 at 20:37

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