Last week, yet another complex development emerged from this summer’s ongoing downturn in the Chinese economy — China’s sudden sale of large amounts of U.S. Treasuries. Though the underlying meaning is elusive, the shift presents a number of possible risks to global finance.
For the past few months, China’s economic slowdown has been accented by a series of major developments that have signaled gradually deeper slides towards instability.
Until now, the most prominent of these developments have been a tumbling stock market and a landmark currency devaluation. However, the end of August has brought forth yet another attention-demanding signpost of Chinese economic distress: the sudden shedding of vast quantities of U.S. Treasuries (USTs) by China’s central bank.
The numbers paint an economic picture in China that strays far from normalcy. In the second half of August alone, China reportedly sold $106 billion in U.S. Treasury bonds — roughly the same amount that it had sold in the first half of the year altogether. Until 2015, the People’s Bank of China (PBoC) had overseen an unprecedented stockpiling of U.S. dollar-denominated assets, expanding from around $150 billion of reserves in 2000 to a peak of $3.69 trillion in 2014.
China first began its unrivaled purchasing of USTs as a response to the trade deficit that has accumulated with the United States since the 1980s. Because China has steadily sold more goods to the U.S. than the U.S. has sold to China, China received a disproportionate amount of U.S. currency from these transactions — creating a surplus of USD, and thereby raising the value of Chinese currency in comparison.
To counter this, China purchased USD from exporters, giving them the renminbi they demanded in exchange, and then recycled the earnings by purchasing USTs. The elaborate strategy kept the renminbi down in comparison to the U.S. dollar and ensured that Chinese exports remained attractive.
In general, U.S. dollars were returned to the global economy while USTs were pulled out, and many came to note the similarities between China’s habitual bond purchasing and quantitative easing — which has essentially the same impact. Now that China has reversed the trend and has started selling off U.S Treasuries in notable force, Deutsche Bank has dubbed the prevailing Chinese response as “quantitative tightening.”
In reality, as Forbes analyst Frances Coppola notes, this title can be misleading, given that selling USTs will, in fact, place a downward “loosening” pressure on the dollar by supporting the yuan through increased liquidity. This confusion surrounding China’s new FX strategy is symbolic of the policy’s broader implications, with the opportunity it presents standing hand-in-hand with sizable risk.
Opportunities from “Quantitative Tightening”
There are two potential and interrelated positive impacts presented by China’s foreign reserves sell-off strategy, at least as far as the general health of the global economy is concerned.
First, China is presently experiencing a staggering pace of capital outflows — $520 billion over the past 5 quarters, according to JPMorgan. The large-scale sale of USTs can help to counter both this and the inherent global economic instability that it entails.
It is therefore an unlikely coincidence that China’s $106 billion dump in the second half of August correlated with a predicted capital outflow rate of roughly $100 billion in that same month. Investors should expect China’s UST sale to continue in similar proportions as a counterweight to any future capital losses.
Second, China’s sale of USTs presents an opportunity to further stabilize the renminbi and prevent heightened disarray in the Chinese stock market. Uncertainty still surrounds the renminbi following August’s 4% devaluation, and a dearth of liquidity threatens to send the renminbi lower yet. Selling U.S. Treasuries provides China the opportunity to boost liquidity and prevent a depreciative trend in the renminbi, making the fall of global economic dominoes less likely.
Risks from “Quantitative Tightening”
At the same time, Beijing’s sudden push to sell USTs poses economic risks to both itself, the United States, and the global economy as a whole.
For one, despite China’s massive foreign currency reserves, its capital outflows have the potential to outpace the safety net that the sale of USTs provides. According to Chinese economist Wei Yao, China currently has $900 billion in USTs available to sell as a means of currency intervention.
Thus, if China continues to be met with capital outflow rates of $100 billion per month, then the current UST supply would only last nine months, and the strategy would quickly become unsustainable. If Beijing sells off its treasury reserves without getting the desired effect of stymied capital outflows, then it loses one of its most important safety nets, and the renminbi can be expected to depreciate even further. This would bring instability to Beijing and abroad.
Furthermore, the massive U.S. Treasury sell off comes with presently unclear but potentially detrimental impacts for the domestic U.S. economy. What can be said with relative safety is that heavy sales of USTs will flood the U.S. Treasury Market, and likely bring yield rates to comparatively high levels in the short-term. Beyond that, higher yields could bring a stronger dollar, though it is yet to be seen if this would be a firm enough push to persuade the Federal Reserve to raise interest rates sooner rather than later.
Together, these opportunities and risks demonstrate precisely how complicated the nature of China’s new FX intervention strategy really is. The uncertainty surrounding Beijing’s UST dump captures the ethos of the nation’s overall strategy for handling its current economic struggles — a bundle of policies with often conflicting and contradictory outcomes.
By stretching its hand to manipulate each and every facet of its domestic economy, China has created a scenario where it is prone to negating the benefits of one policy with the risks of another.
