Tuesday, October 11, 2011
Wayne M. Morrison
Specialist in Asian Trade and Finance
Specialist in Macroeconomic Policy
Given its relatively low savings rate, the U.S. economy depends heavily on foreign capital inflows from countries with high savings rates (such as China) to meet its domestic investment needs and to fund the federal budget deficit. The willingness of foreigners to invest in the U.S. economy and purchase U.S. public debt have helped keep U.S. real interest rates relatively low, which, until recently, contributed to rapid U.S. economic growth. However, many economists contend that U.S. dependency on foreign savings was a contributing factor to the U.S. housing bubble and subsequent global financial crisis.
China’s policy of intervening in currency markets to limit the appreciation of its currency against the dollar (and other currencies) has made it the world’s largest and fastest growing holder of foreign exchange reserves, which totaled $3.2 trillion as of June 2011. China has invested a large share of these reserves in U.S. private and public securities, which include long-term (LT) Treasury debt, LT U.S. agency debt, LT U.S. corporate debt, LT U.S. equities, and short-term debt. As of June 2010, China was the largest holder of U.S. securities, which totaled $1.6 trillion. China’s holdings of U.S. Treasury securities, which are used to help finance the federal budget deficit, totaled $1.17 trillion as of June 2011, which were 25.9% of total foreign holdings.
The U.S. public debt has risen sharply over the past decade, reaching $14.3 trillion as of March 2011. Of this amount, 41.8% was held by U.S. government trust funds and 58.2% was privately held. Foreign investors held 53.8% of privately-held U.S. public debt, up from 35.0% in March 2001.The large and growing U.S. public debt has raised concerns over the willingness of foreigners, including China, to continue to invest in U.S. public debt securities. For example, 2009, Chinese Premier Wen Jiabao stated that he was “a little worried” about the safety of China’s holdings of U.S. debt. The recent debate in Congress over raising the public debt ceiling and the downgrade of the U.S. long-term sovereign credit from AAA to AA + by Standard and Poor’s in August 2011 have renewed Chinese concerns. Editorials in China’s state-run media have sharply criticized U.S. fiscal and monetary policies. Some Chinese analysts have urged the government to diversify its reserves away from U.S. dollar assets. while others have called for more rapid appreciation of China’s currency, which could lessen the need to hold U.S. assets.
Some U.S. policymakers have expressed concern over the size of China’s large holdings of U.S. government debt. For example, some contend that China might decide to sell a large share of its U.S. securities holdings. This could induce other foreign investors to sell off their U.S. holdings as well, which could destabilize the U.S. economy. Others argue that China could use its large holdings of U.S. debt as a bargaining chip in its dealing with the United States on economic and noneconomic issues. In the 112th Congress, H.R. 2166 and S. 1028 would seek to increase the transparency of foreign ownership of U.S. debt instruments, especially China’s, in order to assess if such holdings posed potential risks for the United States. H.R. 1540 would require the Secretary of Defense to conduct a national security risk assessment of U.S. federal debt held by China. Many analysts argue that China’s holdings of U.S. debt give it little leverage over the United States, arguing that as long as China continues to peg its currency mostly to the U.S. dollar, it will have few options other than to keep investing in U.S. dollar assets. Any attempt by China to sell a large portion of its dollar holdings could reduce the value of its remaining dollar holdings, and any subsequent negative shocks to the U.S. (and global) economy could dampen U.S. demand for Chinese exports. They contend that the main issue for U.S. policymakers is not China’s large holdings of U.S. securities per se, but rather the high U.S. reliance on foreign capital in general, including in the public debt, and whether that reliance is sustainable.
Date of Report: September 26, 2011
Number of Pages: 22
Order Number: RL34314
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