Will China Buy our Treasuries?

I don't quite have the answer to that question, but I would argue that the question itself reflects some common confusion.

If all exchange rates are free to adjust to market forces, they would tend to produce a balance between each country's trade with the rest of the world. Strictly speaking, that assumes no unruly capital flows to complicate matters. But while market forces tend to promote trade balance with all other countries combined, there is no reason to expect the market to balance trade on a bilateral, country-by-country, basis.

However, since China has a large trade surplus and the U.S. has a large trade deficit, chances are we will have a large trade deficit with China. China has allowed the yuan to appreciate in recent years, but not to the extent that market forces alone would have likely produced. To hold the yuan down relative to the dollar China buys dollars, which, conversely, holds the dollar up relative to the yuan.

What do I mean by "buying dollars"? In the first instance, the dollars purchased are probably claims on U.S. banks (deposits). Those are then used to purchase U.S. Treasury securities to have claims totally safe from credit risk and in a very liquid market. China could, and is, diversifying by purchasing claims denominated in other currencies, but as long as it is running trade surpluses it has to hold some countries' assets, and as long as the U.S. is running trade deficits someone must accumulate its assets. The quantity of assets to be held is determined, not separately, but as part of the process of incurring the deficit. It is not a separate and independent decision.

Looking at it from another perspective, China is a huge saver with a current account surplus, and, as long as we have low savings and a large current account deficit, China will continue accumulating dollars.

To repeat, my point is that the decision to buy or hold U.S. Treasuries really isn't a separate, independent decision. China's accumulation of dollar assets is part of the same arithmetic as the size of its surplus. They are mutually determined rather than independently determined.

One way to think of it is that we are buying more from the rest of the world (mainly China) in the form of imports of goods and services than we are selling to the rest of the world in the form of exports. If we aren't fully paying for our imports with exports of goods and services, we must make up the difference by selling assets (in the form of debt or equities or direct investment) or incurring new foreign debt. To the extent that China doesn't import goods and services to the extent that they are exporting goods and services, they have to take the difference in increased foreign assets or reduced foreign debt.

This may be harder to follow, but, in effect, the capital account counterpart to our deficit with China- the capital inflow- fills the gap in U.S. saving. Our business sector saves some, but our personal saving rate has been near zero and our government saving (budget surplus) has been negative. Since our investment is positive and much greater than our aggregate domestic saving, the difference is made up by the capital inflow that finances our external deficit. From China's viewpoint, they are investing their excess saving in U.S. assets.

A technical point: In the previous post, where the focus was on the impact of trade on our GDP, I used trade in goods and services. When we export goods and services, income is generated at home. When we import goods and services, income is generated abroad. In this piece, however, the focus is on trade's impact on exchange rates and total saving. For that purpose, we need to include some international transactions in addition to trade in goods and services. We need the "current account" concept, which includes trade, but also unilateral transfers, income on investments in the other countries, etc. The distinction isn't important for must purposes, but I don't want to imagine my international trade professors rolling over.

In case I've totally lost you, the short answer to the question posed by the title is that it's not a separate, independent decision. It's mutually determined by the size of China's trade surplus and our deficit.

Comments (6)

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  1. John Booke says:

    China must keep its currency, the yuan, low compared to our dollar if they want to sell their products in the US. If they do not then Americans will buy goods from China’s competitors and less goods from China. Now more than in long time Americans are very very price conscience. American shoppers are the rare life blood of world trade. There are no replacements. China has to buy US treasuries or the heart of its economy will stop beating.

  2. K T Cat says:

    They can want to buy our Treasuries all day long. The simple math of the situation shows that they can’t buy enough of them to keep their existing investments from eroding. I suspect they’ve already done this math.

  3. hoho says:

    i don’t know whether China will keep buying more.

    but there are possibilities, if , and only if China is a savvy investor, well, like me.

    i would like to share such a nightmare with Americans.

    first, i would tolerate the ups and downs of treasuries so long as Fed doesn’t print money like crazy. oops… now that Americans are debasing the true national treasure of U.S.A., that is, the greenback as the world currency, all i have to do is go to Vanguard and buy the heck pile of index funds on a continuous basis.

    not because that i admire Mr. Bogle so much,(as a matter of fact i do), but because there is not too much left yet logically sound.

    let’s see what we’ll get?
    the capital doesn’t flow back to China. the excuses to trade China’s currency up does not exist.
    even though Fed doesn’t want the rates to rise, as long as China dumps the treasuries ,say 10% of its holding at one time, the man-made treasuries bubble is all gone. rates, from treasuries yield to 30-yr mortgage fixed, will pop like a Christmas tree.

    Fed prints more money, i dump more treasuries, and buy more Vanguard index funds.i don’t need to go to Harvard to figure out how to fight the ultra inflation in the foreseeable future.

    guess what? Communist China could own America, lock , stock and barrel. how about Americans’ 401(k)s all denominated in RMB yuan some day?

  4. Karen says:

    Couldn’t China buy other American assets such as corporate bonds, stocks, entire companies, or real estate (instead of Treasuries)?

    Couldn’t they trade their Treasuries for other countries’ debt instruments (realizing they’d probably have to bid up the prices a bit because they operate on a large scale)?

    Just wondering. I’m no economist, just someone trying to make sense of the risks to our nation’s future.

  5. Kiko says:

    It’s hard to understand how an otieswhre intelligent young man like Ben Katcher is so mystified by what promoters of sanctions seek to achieve. Isn’t it perfectly obvious?Diplomats in the Obama Administration and the editorial writers at the New York Times aren’t stupid; they fully understand that any sanctions regime that is imposed is unlikely to deter Iran from obtaining nuclear weapons if it is chooses to develop them.Imposing sanctions kicks the ball down the field and buys the Administration time. Sanctions placate the Europeans who are bigger Iran hawks than Obama is. Sanctions are a necessary prerequisite to an American military strike against Iran (or American support for an Israeli strike) if that’s the direction the Administration decides to take. In the event that Iran does acquire nuclear weapons (leaving deterrence as the only option for containing Iran) sanctions provide the Administration with an excuse; at least the Administration will be able to say, we tried something; unfortunately it didn’t work. As for the approach the Leveretts and Katcher recommend; forging a grand bargain; it’s increasingly clear that the overwhelming consensus of foreign policy professionals on the right, on the left and in between is that this approach is a fool’s errand. Grand bargain advocates are increasingly viewed as a fringe element now being relegated to the sidelines where they can commune with others of their kind like the 9/11 conspiracy theorists, those who think the Americans (or Israelis) used a death ray to cause the Haiti earthquake and those who think Christopher Marlowe actually authored the plays attributed to Shakespeare.It’s fine if Katcher wants to align himself with this fringe point of view; who knows, maybe it’s even a good career move. But do we really need Katcher to feign ignorance about what sanction supporters are trying to accomplish?He knows perfectly well what they are trying to accomplish.As for the Leveretts, I wonder if they entertain the fantasy that they will ever be able to work as diplomats again. It’s one thing to disagree with the policies of George W. Bush or Barack Obama; it’s another thing to actively root for those policies to fail. The tenor of the posts on this blog makes clear that they’re not just expecting China to thwart American policy on Iran; they’re rooting for China to thwart American policy. In this, they are alot like Chas Freeman whose only regret was that the Chinese were not more brutal in Tiananmen Square than they were.A near universal consensus has developed that sanctions against Iran are the way to go; realists may disagree, but the whole realist school of foreign policy is increasingly anachronistic and now almost completely marginalized. Rooting for the failure of American policy is fine for bloggers, it hardly seems like a recipe for future success in the foreign policy establishment.I hope the Leveretts plan to maintain the Race for Iran far into the future. It’s about the only place that their ideas are likely to be taken seriously..