FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
January 24, 2017
1. China Continues to Sell US Treasuries at a Record Pace
2. Significant Decline in China’s Foreign Exchange Reserves
3. Is China a “Currency Manipulator” as Many Claim?
4. The Largest Foreign Holders of US Treasury Debt
5. What to Expect in President Trump’s First 100 Days
China Continues to Sell US Treasuries at a Record Pace
China is selling US Treasuries at a record pace to support its currency, the Chinese yuan (also known as the renminbi), and to stem the flow of money leaving the country. China’s holdings of US Treasuries declined for a sixth straight month in November, as the world’s second largest economy continued to dip into its dollar-denominated reserves to prop- up a weakening yuan.
China’s holdings of US Treasuries declined to $1.049 trillion in November, a drop of about $66 billion, according to data from the US Treasury Department released last week. November’s drop in China’s holdings was the largest since December 2011’s record fall of $102.7 billion.
In continuous selling over the six months through November, China sold $194.66 billion of Treasuries, and over the previous 12 months it sold $215.11 billion. Both figures are records, according to Reuters.
The People’s Bank of China or “PBOC” (the central bank) is intervening in this particular case by selling US Treasuries and buying yuan in an effort to mitigate the downward pressure on their currency. In other words, the PBOC is trying to avoid further weakness in the yuan.
They are very concerned that unless the yuan is stable, there will be a self-perpetuating acceleration of capital outflows, thus weakening the currency further. No one knows exactly how much or how quickly money is leaving China, but anecdotes and financial reports suggest the outflows are significant.
Significant Decline in China’s Foreign Exchange Reserves
The continued selling in Treasuries coincides with China’s declining foreign exchange reserves, which fell in December to the lowest since February 2011 at $3.011 trillion. China’s foreign exchange reserves have shrunk by over one-fourth since the end of 2013. Since that time, over $1 trillion in capital has moved out of China according to the New York Times.
With a smaller pot of reserves, Chinese leaders have less room to maneuver should the economy undergo a sudden shock. The reserves decline also weakens China’s control over the value of the yuan. The drop in reserves could also hurt China’s efforts to raise its global profile, as it doesn’t have as much money to pump into major projects in developing countries.
The dwindling reserves are one of the many factors shaking global investor confidence because of the impact the slide could have on China’s financial system. A number of investors are now betting that China may have to let its currency depreciate even more, rather than dip further into its reserves.
Is China a “Currency Manipulator” as Many Claim?
Candidate and now President Donald Trump was a frequent critic of China for keeping its currency artificially weak. Of all the countries in the world, he said, China is “the best ever at devaluing its currency.”
Yet as discussed above, today China is shoring up its currency while the rest of the world is trying to push it down. That change speaks to an enormous shift in China’s economic fortunes and to its rising position in the world.
Not too long ago, China was still an up-and-coming country looking for ways to nurture an economic boom that was lifting millions of its people out of poverty. As such, there was an economic benefit to devaluing its currency and it did so often.
The chart above illustrates the change in the number of yuan it takes to equal one US dollar over the last five years. The range has been from around 6.10 to 6.96 yuan to the dollar, or a devaluation of apprx. 14% since the end of 2013. The yuan ended last week at 6.88.
Now, however, China’s leaders want us to believe that it will take whatever measures are necessary to keep the yuan steady, if not stronger. China’s president Xi Jinping basically said as much at last week’s World Economic Forum in Davos, Switzerland.
Today, China is a world power with ambitions to call more of the shots in global economic affairs. Beijing is no longer content to cede that role to the likes of Washington, Brussels, London and Tokyo.
With that shift in attitude comes a change in the way China thinks about its money. A decade ago, China saw its currency as merely a tool to help its factories sell goods overseas. That meant keeping the yuan weak.
Now, China sees the yuan as an instrument of its growing power. If more people around the world hold yuan in their wallets, the thinking goes, then China will have greater say in the decisions world leaders make. Someday, Beijing hopes, the yuan may even rival the US dollar as the world’s de-facto reserve currency. With that in mind, China has pledged to make the yuan more appealing.
Last fall, the International Monetary Fund formally added the yuan to its basket of reserve currencies, lumping it in with the dollar, the pound, the euro and the yen. That was a major accomplishment for China.
Yet critics argue that the move was largely symbolic and the yuan does not fully meet IMF reserve currency criteria of being freely usable, or widely used to settle trade or widely traded in financial markets. Obama’s Treasury Secretary Jack Lew said at the time that the yuan was “quite a ways” from true global reserve currency status.
And then there’s Donald Trump who warned repeatedly on the campaign trail that he would formally label China a “currency manipulator” if the Chinese government devalues the yuan further. Trump has warned he would impose tariffs up to 45% on imports from China if they continue to devalue their currency.
This would be very dangerous as it could spark a major trade war with China. Most observers believe that Trump understands these risks and will be hesitant to pursue such tariffs on China and other trading partners. Let’s hope so.
For all these reasons, China’s leaders have more incentive than ever to support their currency. What that means is China will very likely continue to reduce its holdings of US Treasuries. That does not mean, however, trouble for the US. There is plenty of demand for US sovereign debt around the world.
All of which brings us back to the question: Is China dumping US dollars? Yes, China is selling record amounts of US Treasuries. Yet it is doing so in measured amounts to support its currency. In my view, that doesn’t amount to dumping.
The Largest Foreign Holders of US Treasury Debt
Most American believe that China is the largest foreign holder of US Treasury debt. Not true anymore. Last year Japan became the largest foreign holder of US debt at almost $1.2 trillion, followed by China at just under $1.05 trillion.
As you can see in the partial list above, after Japan and China, the amounts of US