Is China Boycotting US Dollars?

I keeping seeing articles and headlines in various places about how China is revolting against US paper in various ways.  These headlines either say that China is selling off US T-bond holdings or on the verge of rejecting US dollars.  This makes for great headlines and generates lots of page views for those who think China is about to “dump” their Treasury Bond holdings on the world and crash the US bond market, but it is outright misleading and infuriating for anyone who actually understands how the monetary system works.

First of all, let’s go back to basics.  Why does China buy t-bonds in the first place?  Well, China runs a trade surplus with the USA.  So, China sends us pieces of plastic and other cheap goods and services and we send them pieces of paper (or electronic credits if you prefer).  These pieces of paper ultimately end up at the Chinese Central Bank when they are converted from USD to RMB.  So, this all starts because China likes obtaining US Dollars.  Why is this?  Because China generates a huge amount of domestic employment and domestic investment thanks to this continual business coming from the USA.  The USA, in return, gets cheaper goods and services.  It seems like a fair trade for all involved (although the real debate here is whether that’s actually true in the long-run).

So, China wants USDs in the first place.  In fact, China needs USD’s because their economy remains one that is largely built on export growth (thought that’s changing to some degree as time goes on).  So these USDs ultimately end up at the Chinese central bank.  So what can they do with them?  Well, they can either use them to buy something of relative value denominated in USD (like t-bonds or other assets) or they can use the dollars to defend the exchange rate (which China does by pegging the RMB to the USD).

So, long story short – China’s trade strategy directly contradicts anyone who says China is rejecting the USD.  No, they want USDs.  They need USDs.  They enjoy many benefits from obtaining USDs.  And they use many of these USDs to manipulate their exchange rate to keep MORE USDs flowing in.  If China doesn’t want to buy t-bonds then who cares?  If they want to let those pieces of paper sit around collecting dust then great.  That’s less interest we need to pay them!  Also, anyone who understands how a US Treasury auction works knows that indirect bidders are marginal buyers and that the Primary Dealers can ALWAYS take down the entire auction.  So, ignore all this fear mongering about China rejecting the USD. It’s not happening.  And due to China’s growth strategy, it would be against China’s best interest for it to happen.


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. “No, they want USDs. They need USDs.”

    Isn’t it reasonable to assume that at some future point in time, the above claim will become obsolete? To me, this is simply true until it isn’t. There is no absolute structure in place that prevents China from slowly switching gears over time towards non-reliance on US based consumption. Why can’t China eventually produce sufficient domestic demand for the consumption of goods that its domestic industries produce?

  2. China is actually selling USDs. It has a trade surplus and in spite of that the chinese Current Account has turned negative. And that forces China to sell USDs and T-bonds.

  3. Sure, when Chinese businesses decide they don’t need to accumulate USDs. That’s like waiting for WalMart to tell the US consumer to take a hike. Don’t hold your breath on that one. :-)

  4. China runs a total country current account mainly because of nearby imports. But it accumulates more US Dollar assets per year than it sends out because its cuontry specific balance with the USA is overwhelmingly positive.

  5. What China would really like to do with their U.S. dollar holdings is to buy commodity producing assets in North America and around the world. The U.S. has already made it clear (remember UNOCAL?) that buying pieces of their resources is off limits so the Chinese have turned their sights on Canada where they have made some investments in Natural Gas and have made a bid for another large mid-size oil company(Nexen). That bid is being scrutinized by the Canadian Government and it may not be permitted.
    The Chinese must be concerned that at some point, their American dollar holdings may be severely devalued. If they are continually thwarted in their attempts to use those dollars to secure resources for their economy, how much longer will it be before they lose their appetite for American dollars?

  6. 3 month T-bills are yielding 0.09% (12 month T-bills at 0.18%. The Fed is paying reserve accounts 0.25% IOR.

    I’m no math whiz, but only a moron would move money from an interest-bearing demand deposit account to a time deposit account that pays a lower yield.

  7. China runs a current account surplus according to Bloomberg, the WTO, Google, …

  8. Wow, last week you said Iran is experiencing deflation, and this week China has Current Account Deficit. You’re really on a roll of late…

  9. I think they might have had a (current account) deficit month earlier this year but that comes amid over a decade of surpluses. Current account surplus equals a capital account deficit — Maybe that (capital account) is what he was thinking of.

  10. True, that’s why banks are being force into the 5yr and 7yr along with other agency demand notes with their bond portfolios.

  11. I wish we could get our friends in Congress to grasp what Cullen has explained. I also wish Mitt Romney would see the light on MR.

  12. Stephen, that’s the key question in any economic analysis. What happens when things change? Is our current policy robust enough to adjust to a different set of circumstances?

    It will be interesting to see what decision China makes. It doesn’t want to hold dollars, because that is depreciating asset. It preferred to hold T-bonds at 5 percent. It doesn’t seem to want to hold T-bonds at 2 percent, especially if it feels that asset will depreciate.
    There is some evidence it wants to buy hard assets.

    There is the idea that we don’t need China to borrow, that we can simply ask the primary dealers to take down ever-increasing auctions. But again, going back to Stephen’s point, things are true until they aren’t. What then?