China’s holdings of US government debt fell below $1 trillion for the first time in 12 years. Large-scale anti-Russian sanctions have undermined confidence in the main reserve currency. Inflation, which has been at a record level for 40 years, does not add optimism. At the same time, not only Beijing has sharply lost interest in government securities – other central banks are also getting rid of them, writes RIA Novosti.
Less than a trillion
According to the U.S. Treasury Department, in May, China’s portfolio of investments in U.S. government debt stood at $980.8 billion, down 23 from the previous month and nearly 100 from last year. That is, the psychological limit of one trillion is already behind us.
For several years, Beijing has been reducing investments in government securities. The beginning was the trade war unleashed by Washington, and later the technology war. From a peak of 1.32 trillion in November 2014, investment has fallen by more than 200 billion. And by June 2019, the leadership among foreign holders of US government debt passed to Japan.
Undermined trust
Freezing Russia’s international reserves of around $300 billion has had an effect.
A potential asset grab has the world’s second-largest economy on edge. The Chinese fear that in the event of a regional military conflict or other crisis, the Americans will do the same to them. At an emergency meeting in May, financial officials discussed how to protect more than $3 trillion in savings.
The recommendations boiled down to the need to diversify dollar-denominated assets, accelerate international recognition of the Chinese currency, increase the use of the digital yuan in cross-border payments, and generally destroy US financial hegemony in any way possible.
Over the past 20 years, the share of American currency in Beijing’s national reserves has already decreased by a quarter – to 56 percent, while gold has tripled – to almost two thousand tons.
Economists believe that Washington will not touch China’s reserves. This would cause enormous damage to international production and trade chains: China has huge dollar assets and close economic ties with the United States. But Beijing will continue to draw funds from the treasury.
The trillion held by China in US government bonds is gradually “melting away”. The Chinese are actively diversifying their investment portfolio. In particular, they are building up a foreign exchange reserve in yuan to compete with the dollar and support other economies facing instability.
Rampant inflation
The tightening of monetary policy by the Federal Reserve, along with rampant inflation, is also hurting the US debt market. When interest rates rise, bond yields fall and investors who sell them to maturity lose money. It makes no sense to buy securities yielding three percent with dollar inflation accelerating to nine.
In May, the Federal Reserve raised its benchmark interest rates by 50 basis points and in June by another 75 basis points in an attempt to limit record price increases. From the upcoming meeting in July, Wall Street expects a similar decision.
US inflation hit a 40-year high in June. The main reason is the increase in the price of food and consumer goods. US President Biden called it a “curse”. And he said: it is better not to count on the fact that food and fuel will become cheaper in the near future. And Russia is to blame for everything.
The real reason was stated in Bloomberg. “Everything became more expensive due to record high energy prices, which skyrocketed after ill-conceived sanctions against Moscow,” the agency said.
The general trend
Beijing is not the only one to abandon the dollar. According to UBS’s annual survey of the 30 largest central banks from April to June, they are all actively diversifying assets. In addition to China and Japan, investments in treasuries are decreasing in Saudi Arabia and Brazil. Experts note: Foreign investment in US government debt has fallen as fast in the past six months as it did after the election of Donald Trump in 2016 and the start of the pandemic.
“We are seeing a gradual erosion of the dollar,” said Massimiliano Castelli, head of global sovereign markets strategy at UBS. “The picture is emerging of a multipolar monetary system.”
The survey showed that reserve managers are looking to alternatives: stocks, green bonds and inflation-protected securities. Almost half of those surveyed said their portfolios had become more diverse.
The dollar accounted for just under 60 percent of global reserves at the end of the first quarter, compared with 65 percent in the same period in 2016, according to the IMF. The dollar is still the main reserve currency. But the US response to geopolitical tensions may ultimately strip it of its dominance.
There is another problem: if foreign interest in Treasuries continues to weaken, interest rates on them will rise even more. And it will become very difficult to service the enormously inflated national debt. As well as to deal with the huge budget deficit, which is mainly covered by the sale of securities.
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