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 help promote growth and to fund the federal budget deficit. China has intervened heavily in currency markets to limit the yuan’s appreciation. As a result, China has become the world’s largest and fastest growing holder of foreign exchange reserves (FER), which totaled $1.5 trillion at the end of 2007.

China has invested a large share of its FER in U.S. securities, which, as of June 2007, totaled $922 billion, making China the 2nd largest foreign holder of U.S. securities (after Japan). These securities include long term Treasury debt, U.S. agency debt, U.S. corporate debt, U.S. equities, and short term debt.

U.S. Treasury securities are issued to finance the federal budget deficit. Of the public debt that is privately held, about half is held by foreigners. As of March 2008, China’s Treasury securities holdings were $491 billion, accounting for 19.5% of total foreign ownership of U.S. Treasury securities and making China the second largest foreign holder of U.S. Treasuries after Japan.

Some U.S. policymakers have expressed concern that China might try to use its large holdings of U.S. securities, including U.S. public debt, as leverage against U.S. policies it opposes. For example, various Chinese government officials are reported to have suggested that China could dump (or threaten to dump) a large share of its holdings to prevent the United States from implementing trade sanctions against China’s currency policy. Other Chinese officials have reportedly stated that China should diversify its investments of its foreign exchange reserves away from dollardenominated assets to those that offer higher rates of returns.

A gradual decline in China’s holdings of U.S. assets would not be expected to have a negative impact on the U.S. economy (since it be matched by increased U.S. exports and a lower trade deficit). However, some economists contend that attempts by China to unload a large share of its holdings U.S. securities holdings could have a significant negative impact on the U.S. economy (at least in the short run), especially if such a move sparked a sharp depreciation of the dollar in international markets and induced other foreign investors to sell off their U.S. holdings as well.

In order to keep or attract that investment back, U.S. interest rates would rise, which would dampen U.S. economic growth, all else equal. Other economists counter that it would not be in China’s economic interest to suddenly sell off its U.S. investment holdings. Doing so could lead to financial losses for the Chinese government, and any shocks to the U.S. economy caused by this action could ultimately hurt China’s economy as well.

The issue of China’s large holdings of U.S. securities is part of a larger debate among economists over how long the high U.S. reliance on foreign investment can be sustained, to what extent that reliance poses risks to the economy, and how to evaluate the costs associated with borrowing versus the benefits that would accrue to the economy from that practice. This report will be updated as events warrant.

Download China’s Holdings of U.S. Securities: Implications for the U.S. Economy

PDF format, 120KB, 16Pages.

CRS Report for Congress
Updated May 19, 2008

Wayne M. Morrison
Specialist In International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Marc Labonte
Specialist in Macroeconomic Policy
Government and Finance Division

Contents
China’s Foreign Exchange Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
China’s Holdings of U.S. Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
China’s Ownership of U.S. Treasury Securities . . . . . . . . . . . . . . . . . . . . . . 6
U.S. Concerns Over China’s Large Holdings of U.S. Securities . . . . . . . . . . . . . . 8
What If China Reduces its Holdings of U.S. Securities? . . . . . . . . . . . . . . . . . . . . 9
Concluding Observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Concluding Observations

Many economists argue that concerns over China’s holdings of U.S. securities represent part of a broader problem for the U.S. economy, namely its dependence on foreign saving to finance its investment needs and federal budget deficits. The large U.S. current account deficit (the manifestation of the high U.S. saving/investment gap) cannot be sustained indefinitely because the U.S. net foreign debt cannot rise faster than GDP indefinitely.

Some economists argue that at some point foreign investors may view the growing level of U.S. foreign debt as unsustainable or more risky, or they may no longer view U.S. securities as offering the best return on their investment, and shift investment funds away from U.S. assets, thus forcing U.S. interest rates to rise to attract needed foreign capital. This would result in higher interest rates and lower investment rates, all else equal, which would reduce longterm growth.

Other economists contend that, although the low U.S. savings rate is a problem, the U.S. current account deficit and high levels of foreign capital flows to the United States are also reflections of the strength of the U.S. economy and its attractiveness as a destination for foreign investment, and therefore discount the likelihood that foreign investors will suddenly shift their capital elsewhere.

The United States continues to press China to make its currency policy more flexible so that the yuan will appreciate more significantly against the dollar and to adopt policies that promote domestic consumption as a major source of China’s economic growth (as opposed to export and fixed investment-led growth that has resulted from China’s currency policy). This is viewed as a major step towards reducing global trade imbalances, including the large U.S.-China trade imbalance.

However, in order for that to occur, the United States must also boost its level of savings. If China consumed more and saved less, it would have less capital to invest overseas, including in the United States. Thus, if the United States did not reduce its dependence on foreign savings for its investment needs, and China reduced its U.S. investments, the United States would need to obtain investment from other countries, and the overall U.S. current account balance would likely remain relatively unchanged.

Comments (0)

Show/Hide comments

Name

Email

Website

Title

Comment

smaller | bigger

Add Comment