China's Holdings of U.S. Securities: Implications for the U.S. Economy
Prepared for Members and Committees of Congress
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
appreciation of its currency, especially against the dollar. As a result, China has become the
world’s largest and fastest growing holder of foreign exchange reserves (FER). China has
invested a large share of its FER in U.S. securities, which, as of June 2007, totaled $922 billion, nd
making China the 2 largest foreign holder of U.S. securities (after Japan). These securities
include long-term (LT) Treasury debt, LT U.S. agency debt, LT U.S. corporate debt, LT 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 October 2008, China’s Treasury securities
holdings were $653 billion, accounting for 21.5% of total foreign ownership of U.S. Treasury
securities, making it the largest foreign holder of U.S. Treasuries (replacing Japan in September
2008). China’s holdings of U.S. Treasuries rose by $45 billion September 2008 and by $66
billion in October, reflecting in part a movement by China away from purchases of U.S. agency
asset backed securities (such those issued by Fannie Mae and Freddie Mac) to more “safe” U.S.
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, in the past, some Chinese officials reportedly suggested that China could dump (or
threaten to dump) a large share of its holdings to prevent the United States from imposing trade
sanctions against China over its currency policy. Other Chinese officials reportedly stated that
China should diversify its investments of its foreign exchange reserves away from dollar-
denominated assets to those that offer higher rates of returns. The recent global financial crisis
has heightened U.S. concerns that China might reduce its U.S. asset holdings.
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 could 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 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.
China’s Foreign Exchange Reserves...............................................................................................1
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....................................................7
What If China Reduces its Holdings of U.S. Securities?................................................................8
Figure 1. China’s Holdings of U.S. Securities: June 2002-June 2007.............................................4
Figure 2. Composition of China’s Holdings of U.S. Securities as of June 2007.............................6
Table 1. China’s Foreign Exchange Reserves: 2001-September 2008............................................2
Table 2. Top 5 Holders of Foreign Exchange Reserves and Changes to Holdings From
Table 3. Top Five Foreign Holders of U.S. Securities as of June 2007...........................................5
Table 4. Major Foreign Holders of U.S. Treasury Securities: October 2007 and October
2008 .............................................................................................................................................. 7
Author Contact Information..........................................................................................................12
ecause of its low savings rate, the United States borrows to finance the federal budget
deficit and its capital needs in order to enjoy healthy economic growth. It therefore
depends on countries with high savings rates, such as China, to invest some of its capital B
in the United States.
China’s central bank is a major purchaser of U.S. assets, largely because of its exchange rate
policy. In order to mitigate the yuan’s appreciation against the dollar, China’s central bank must 1
purchase U.S. dollars. This has led China to amass a huge level of foreign exchange reserves
(FER); these totaled $1.9 trillion as of September 2008. Rather than hold dollars, which earn no
interest, the Chinese central government has converted some level of its FER holdings into
financial securities. Since foreign exchange holdings facilitate trade and prevent speculation
against their currency, the central bank also holds securities from other foreign countries. The
United States is a major destination of China’s overseas investment. China is the second largest
holder of U.S. securities, which include U.S. Treasury securities that are used to finance the
federal budget deficit. Some U.S. policymakers have expressed concern that China’s large
holdings of U.S. securities may pose a risk to the U.S. economy should China stop purchasing
those securities or attempt to divest itself of a large share of its holdings. In addition, China’s FER
are expected to continue to grow rapidly in the near future, potentially continuing (and possibly
increasing) China’s role as a major buyer of U.S. securities.
The recent financial crisis in the United States and the Administration’s proposed plans to
purchase troubled assets is expected to cost the government hundreds of billions of dollars, at
least initially. This will require a substantial level of new government borrowing, some of which
will likely be financed by foreign investors. China could be a major purchaser of new U.S.
This report examines the importance to the U.S. economy of China’s investment in U.S.
securities, as well as U.S. concerns over the possibility that China might unload a large share of
those holdings, the likelihood that this would occur, and the potential implications such action
could have for the U.S. economy. The report concludes that a large sell-off of Chinese Treasury
securities holdings could negatively affect the U.S. economy, at least in the short-run. As a result,
such a move could diminish U.S. demand for Chinese products and thus could lower China’s
economic growth as well. The issue of China’s large holdings of U.S. securities is part of a
broader question that has been raised by many economists: What are the implications of the
heavy U.S. reliance on foreign investment to maintain healthy economic growth and to finance 2
the budget deficit?
As indicated in Table 1, China’s foreign exchange reserves have increased sharply in recent
years, both in absolute terms and as a percent of gross domestic product (GDP). These rose from
1 China’s accumulation of foreign exchange reserves has also occurred because of large annual current account trade
surpluses, high levels of foreign direct investment in China, and inflows of “hot money” from overseas investors who
anticipate that the Chinese government will appreciate the yuan in the near future. For additional information, see CRS
Report RL32165, China’s Currency: Economic Issues and Options for U.S. Trade Policy, by Wayne M. Morrison and
2 For a discussion of the implications of a possible global sell-off of U.S. securities, see CRS Report RL34319, Foreign
Ownership of U.S. Financial Assets: Implications of a Withdrawal, by James K. Jackson.
$216 billion in 2001 to $1,528 billion in 2007 (and hit $1,906 billion as of September 2008).
China’s reserves as a percent of GDP grew from 18.1% in 2001 to 47.1% in 2007 – an unusually
high level for a large economy.
Table 1. China’s Foreign Exchange Reserves: 2001-September 2008
Year Billions of U.S. Dollars As a % of Chinese GDP
2001 215.6 18.1
2002 291.1 22.1
2003 403.3 28.1
2004 609.9 31.5
2005 818.9 35.5
2006 1,068.5 38.6
2007 1,528.2 47.1
September 2008 1,905.6 N.A.
Source: International Monetary Fund (IMF) and Chinese State Administration of Foreign Exchange.
Note: Year-end values (except for 2008).
A listing of the world’s top five holders of FER as of September 2008 is shown in Table 2. Not
only was China by far the world’s largest FER holder, its accumulation of additional reserves
from 2006-September 2008 ($830 billion) was larger than the combined FER increases of the 3
other four major holders – Japan, Russia, India, and Taiwan. According to the IMF, as of 4
December 2007, China accounted for 23.9% of the world’s FER.
Table 2. Top 5 Holders of Foreign Exchange Reserves and Changes to Holdings
From 2006-September 2008
Reserves (billions of U.S. dollars) Country
2006 Year End 2007 Year End September 2008 Dollar Change: 2006-
China 1,068.5 1,528.2 1,905.6 837.1
Japan 879.7 948.4 969.2 89.5
Russian Federation 295.3 386.2 402.3 107.0
India 170.2 266.6 277.3 107.1
Taiwan 266.1 270.0 281.1 15.0
Sources: EIU Database, IMF International Financial Statistics, and Central Bank of the Republic of China
Note: Ranked according to total holdings as of September 2008.
3 China overtook Japan in 2006 to become the world’s largest holder of FER.
4 Total reserves for all countries in 2007 were estimated at $6,390 billion. Worldwide, 41% of reserves were held in
China’s central bank is a major purchaser of U.S. financial securities because of its exchange rate
policy. In order to mitigate the yuan’s appreciation against the dollar, the central bank must
purchase dollars. Rather than hold dollars, which earn no interest, the Chinese central government
has converted some level of its foreign exchange holdings into financial securities. Since foreign
exchange holdings facilitate trade and prevent speculation against their currency, the central bank
also holds securities from other foreign countries.
There are no official estimates of what share of China’s foreign reserves are held in dollar-
denominated assets (assets that were bought with dollars and are cashed in dollars), but the
Treasury Department conducts an annual survey of foreign portfolio holdings of U.S. securities 6
by country, and reports data for the previous year as of the end of June. The report does not
distinguish between government and private holdings of U.S. securities. U.S. securities include 7
long-term (LT) U.S. Treasury securities, LT U.S. government agency securities, LT corporate 8
securities (some of which are asset-backed), equities (such as stocks), and short-term debt.
According to the latest Treasury survey (released in April 2008), China’s total holdings of U.S.
securities of $927 billion at the end of June 2007 were more than triple its holdings in 2003 (see 9
Figure 1). From June 2006 to June 2007, China’s U.S. securities holdings grew by $223 billion 10
(or 32%), far more than any other country’s. At the current rate, China could become the largest
foreign holder of U.S. securities in a year or two.
5 For additional information on foreign ownership of U.S. securities, see CRS Report RL32462, Foreign Investment in
U.S. Securities, by James K. Jackson.
6 Note, Treasury’s annual survey does not include data on foreign direct investment (FDI) in the United States, which
measures foreign ownership or investment in U.S. businesses. China’s total FDI in the U.S. at the end of 2006 was
$554 million (on a historical cost basis), according the U.S. Bureau of Economic Analysis. Since these types of assets
cannot be liquidated rapidly, they are not included in this report.
7 Agency securities include both federal agencies and government-sponsored enterprises created by Congress (e.g.,
Fannie Mae and Freddie Mac) to provide credit to key sectors of the economy. Some of these securities are backed by
assets (such as home mortgages).
8 LT securities are those with no stated maturity date (such as equities) or with an original term to maturity date of more
than one year. Short-term debt includes U.S. Treasury securities, agency securities, and corporate securities with a
maturity date of less than one year.
9 Data on China’s holdings of U.S. securities exclude holdings by Hong Kong (which totaled $137.8 billion as of June
2007) and Macao ($2.0 billion). These entities, though part of China, are reported separately by Treasury.
10 In comparison, Japan’s holdings grew by only $91 billion. U.S. Treasury, Report on Foreign Portfolio Holdings of
U.S. Securities as of June 30, 2007, April 2008, p. 11-12.
Figure 1. China’s Holdings of U.S. Securities: June 2002-June 2007
$ b illio n s
2002 2003 2004 2005 2006 2007
Source: U.S. Treasury Department.
As indicated in Table 3, China was the second largest foreign holder of U.S. securities, after 11
Japan. China’s main holdings were in LT Treasury securities and LT government agency 12
securities (see Figure 1). This likely indicates that a large share of China’s holdings of U.S.
securities are controlled by the Chinese government and that it has been pursuing a relatively
low-risk investment strategy. In contrast, most of the United Kingdom’s securities holdings were
in corporate debt and equities. China’s holdings of U.S. securities accounted for 9.4% of total
foreign holdings of U.S. securities as of June 2007.
Although the Chinese government does not make public the dollar composition of its foreign 13
exchange holdings, many analysts estimate this level to be around 70%. If this figure is correct,
China’s holdings of U.S. securities may have reached $1.3 trillion as of September 2008.
11 According to the Treasury Department, data on foreign holdings of U.S. securities should be treated with caution,
due to the difficulty in obtaining accurate information on the actual foreign owners of U.S. securities. For example,
chains of foreign financial intermediaries may be involved in the custody or management of these securities.
12 China was the largest foreign holder of LT U.S. agency securities, accounting for 29% of total foreign holdings of
these type of securities.
13 See testimony of Brad Setser, Senior Economist, Roubini Global Economics and Research Associate, Global
Economic Governance Programme, University College, Oxford, before the House Budget Committee, Foreign
Holdings of U.S. Debt: Is our Economy Vulnerable?, June 26, 2007, p. 11. In addition, the People’s Daily Online
(August 28, 2006) estimated China’s dollar holdings to total FER at 70%. A rough estimate can be made by taking the
value of China’s holdings of U.S. securities ($922 billion at the end of June 2007) and dividing it by China’s foreign
exchange reserves ($1,333 billion at the end of June 2007), which would equal 69.2%.
It is not clear to what extent China’s investments have gone into U.S. sub-prime mortgage
securities, but they are likely to be small relative to their total investments. As seen in Table 3,
China has invested $376 billion in long-term agency securities, most—but not all—of which is
likely to be debt issued by Fannie Mae and Freddie Mac. The South China Morning Post
(September 25, 2008) estimated that Chinese banks held $9.8 billion in U.S. sub-prime loans at
the end of 2007 and $25 billion in Fannie Mae and Freddie Mac securities as of June 30, 2008.
Whatever risk China faced from its holdings of Freddie Mac and Fannie Mae mortgage-backed
securities was greatly reduced in September 2008 when these two institutions were placed in
conservatorship by the Federal Government and thus have government backing. The Bank of
China (one of China’s largest state-owned commercial banks) reportedly had the largest
exposures to U.S. sub-prime mortgage-backed securities among any banks in Asia when the
financial crisis began. However, it reported that holdings of such securities as a share of its total
investment securities portfolio were reduced from 3.5% in March 2008 to 1.4% in October 14
Table 3. Top Five Foreign Holders of U.S. Securities as of June 2007
LT LT Short
Total LT Treasury Government Corporate Equity Term
Japan 1,197 553 229 119 220 76
China 922 467 376 28 29 23
United Kingdom 921 43 28 405 421 24
Cayman Islands 740 23 52 347 279 38
Luxembourg 703 45 39 340 233 44
World Total 9,772 1,965 1,305 2,737 3,130 635
as a % of World
Total 9.4 23.8 28.8 1.0 0.9 3.6
Source: U.S. Treasury Department, Report on Foreign Portfolio Holdings of U.S. Securities as of June 30, 2007, April
2008, p. 8.
Note: LT securities are those with no stated maturity date (such as equities) or with an original term to
maturity date of more than one year. Short term securities have a maturity period of less than one year.
14 The Bank of China either reduced its holdings or wrote off the losses.
Figure 2. Composition of China’s Holdings of U.S. Securities as of June 2007
LT AgencyLT Coporate
40.8% 3.0 %Eq u i t y
Source: Department of Treasury.
Note: LT stands for long-term debt.
U.S. Treasury securities are the main vehicle the U.S. government uses to finance the federal
debt, which totaled $10.0 trillion at the end of September 2008. Of this amount, 47% was held by
U.S. government trust funds and 53% was privately held. Of the total level of privately-held U.S. 16
Treasury securities ($5.3 trillion), foreigners owned 54% of the total ($2.9 trillion). China’s
holdings of U.S. Treasury securities holdings (as of September 2008) accounted for 11.0% of total
private holdings (including foreign governments and citizens) of U.S. Treasury securities and 17
Table 4 lists the top five major foreign holders of U.S. Treasury securities as of October 2008.
China was the largest holder of U.S. Treasury Securities (overtaking Japan in September 2008) th18
at $653 billion (China was the 7 largest holder in December 1997). Over the past few years,
China has become a major purchaser of Treasury securities. From December 2001 to October
2008, China’s share of total foreign holdings of U.S. Treasury securities rose from 7.6% to
21.5%. From October 2007 to October 2008, China’s holdings increased by $193.8 billion (or
During this period, China accounted for 26.1% of net new holdings of U.S. Treasury securities.
China’s purchases of U.S. Treasury securities were relatively large in September and October
15 For a general discussion of foreign ownership of U.S. debt, see CRS Report RS22331, Foreign Holdings of Federal
Debt, by Justin Murray and Marc Labonte.
16 U.S. Treasury Department, Financial Management Service, Ownership of Federal Securities, available at
17 Although yields on U.S. Treasury securities are relatively low compared to other types of investment, they are also
considered to be relatively low in risk. Thus they are viewed by many central banks to be a safe investment for their
18 Treasury constantly revises its estimates of foreign holdings of U.S. securities. Thus, data which compares historical
Treasury data with current data should be viewed with caution.
2008, at $44.6 billion and $65.9 billion, respectively. This may in part reflect a movement by
China (and other foreign investors) away from purchases of U.S. agency asset backed securities
(such those issued by Fannie Mae and Freddie Mac) to more “safe” U.S. government securities.
Table 4. Major Foreign Holders of U.S. Treasury Securities:
October 2007 and October 2008
Oct 2007-Oct 2008 Holdings as a
Oct 2007 Oct 2008 Change in the Value of its Share of Total Foreign Holdings
Holdings as of Oct2008 (%)
China 459.1 652.9 193.8 21.5
Japan 601.7 585.5 -16.2 19.2
United Kingdom 155.0 360.2 205.2 11.8
Banking Centers 105.6 219.5 113.9 7.2
Oil Exportersa 141.6 187.7 46.1 6.2
Holdings 2,299.2 3,042.7 743.5 100.0
Source: Department of Treasury, Major Foreign Holders of Treasury Securities Holdings, December 15, 2008.
a. Oil exporters include Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar,
Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria.
Note: *Data are based on surveys which are done annually or biannually. A new survey may often significantly
revise data of a previous survey. Thus, time series data should be viewed with caution.
Some U.S. policymakers have expressed concern over China’s large holdings of U.S. securities,
including Treasury securities, contending that China could use it as a political tool against the
United States. To illustrate, an August 7, 2007 article in the Telegraph (an online British
newspaper) cited interviews with officials from two leading Chinese government think tanks who
reportedly stated that China had the power to make the dollar collapse (if it chose to do so) by
liquidating large portions of its U.S. Treasury securities holdings if the United States imposed
trade sanctions to force a yuan revaluation, and that the threat to do so could be used as a 19
“bargaining chip.” The article prompted concern among many U.S. policymakers, including
Senator Chuck Grassley, who, in an August 9, 2007 letter to the Chinese ambassador to the
United States (Zhou Wenzhong), called the comments “dangerous” and a factor in why the United
States “is right to be concerned with China’s currency practices.” The letter asked the Chinese
government to confirm that “the comments do not reflect the official position of the Chinese 20
government.” In response, the Chinese ambassador wrote to Senator Grassley on August 13,
19 The Telegraph, China Threatens ‘Nuclear Option’ of Dollar Sales, August 7, 2007.
20 See text of letter at http://grassley.senate.gov/public/.
In addition, China’s Xinhua News Agency on August 13, 2007, quoted an unnamed official at the
People’s Bank of China as stating that “dollar-denominated assets, including U.S. government
securities, are an important component in China’s foreign exchange reserve investment portfolio,”
and that China was “a responsible investor.”
Numerous reports have appeared in the media citing various Chinese officials who have claimed
or hinted at government plans to reduce its holdings of U.S. Treasury securities for economic
reasons. For example, on September 29, 2007, the Chinese government officially launched the
state-owned China Investment Corporation, which Chinese officials state was created to better
manage its foreign exchange reserves. It reportedly will initially manage over $200 billion of
China’s reserves, making it one of the world’s largest sovereign wealth funds. Some contend the
creation of this entity could signal Chinese plans to diversify away from relatively low-yielding 22
assets, such as Treasury securities, and perhaps dollar-denominated assets in general. On
November 7, 2007, Cheng Siwei, the vice chairman of the Chinese National People’s Congress,
reportedly made remarks that the Chinese government “will favor stronger currencies over
weaker ones, and will readjust accordingly.” The media claimed that his remarks were a major
factor in sparking a sharp decline of the dollar against the euro in international currency markets 23
that day. However, on November 14, 2007, Yi Gang, assistant governor of the People’s Bank of
China, was quoted as saying that “the U.S. dollar is the main currency in our reserves and that
policy remains very firm,” and said that statements by other officials to the contrary were 24
Some U.S. policymakers have recently raised concerns that China, for economic reasons (such as
concerns over the safety of its current holdings of U.S. securities), might seek to liquidate such
assets or significantly cut back on purchases of new securities. These fears have been heightened 25
as a result of the U.S. sub-prime mortgage crisis and the subsequent global financial crisis.
As the previous data illustrate, China has accumulated large holdings of U.S. assets in recent
years. These accumulations are the result of U.S. borrowing to finance its large trade deficit with
China (the gap between U.S. exports and Chinese imports). All else equal, Chinese government
purchases of U.S. assets increases the demand for U.S. assets, which reduces U.S. interest rates.
21 Letter reprinted in Inside U.S. Trade, August 13, 2007.
22 Others are concerned that China will attempt to use the fund to purchase major U.S. companies. See the New Yorker,
Sovereign Wealth World, November 26, 2007. According to the article, “were China’s fund so inclined, it could buy
Ford, G.M., Volkswagen, and Honda, and still have a little money left over for ice cream.”
23 Bloomberg News, November 8, 2007.
24 China Daily, November 15, 2007.
25 See CRS Report RL34742, The U.S. Financial Crisis: The Global Dimension with Implications for U.S. Policy, by
Dick K. Nanto et al.
26 From the perspective of the macroeconomic effects on U.S. investment, interest rates, and so on, it does not matter
what type of U.S. security is purchased when foreign capital flows to the United States. Thus, Chinese purchases of all
types of U.S. securities (not just Treasury securities) should be considered when attempting to understand the impact
China’s investment decisions have on the U.S. economy.
If China attempted to reduce its holdings of U.S. securities, they would be sold to other investors
(foreign and domestic), who would presumably require higher interest rates than those prevailing
today to be enticed to buy them. One analyst estimates that a Chinese move away from long-term 27
U.S. securities could raise interest rates by as much as 50 basis points. Higher interest rates
would cause a decline in investment spending and other interest-sensitive spending. All else
equal, the reduction in Chinese Treasury holdings would cause the overall foreign demand for
U.S. assets to fall, and this would cause the dollar to depreciate. If the value of the dollar
depreciated, the trade deficit would decline, as the price of U.S. exports fell abroad and the price 28
of imports rose in the United States. The magnitude of these effects would depend on how many
U.S. securities China sold; modest reductions would have negligible effects on the economy
given the vastness of U.S. financial markets.
Since China held $922 billion of U.S. government assets as of June 2007 (and possibly $1.3
trillion as of September 2008), any reduction in its U.S. holdings could potentially be large. If
there were a large reduction in its holdings, the effect on the U.S. economy would still depend on
whether the reduction were gradual or sudden. It should be emphasized that economic theory
suggests that a slow decline in the trade deficit and dollar would not be troublesome for the
overall economy. In fact, a slow decline could even have an expansionary effect on the economy,
if the decrease in the trade deficit had a more stimulative effect on aggregate demand in the short
run than the decrease in investment and other interest-sensitive spending resulting from higher
interest rates. Historical experience seems to bear this out—the dollar declined by about 40% in
real terms and the trade deficit declined continually in the late 1980s, from 2.8% of GDP in 1986
to nearly zero during the early 1990s. Yet economic growth was strong throughout the late 1980s.
A potentially serious short-term problem would emerge if China decided to suddenly reduce their
liquid U.S. financial assets significantly. The effect could be compounded if this action triggered
a more general financial reaction (or panic), in which all foreigners responded by reducing their
holdings of U.S. assets. The initial effect could be a sudden and large depreciation in the value of
the dollar, as the supply of dollars on the foreign exchange market increased, and a sudden and
large increase in U.S. interest rates, as an important funding source for investment and the budget
deficit was withdrawn from the financial markets. The dollar depreciation would not cause a
recession since it would ultimately lead to a trade surplus (or smaller deficit), which expands 29
aggregate demand. (Empirical evidence suggests that the full effects of a change in the
exchange rate on traded goods takes time, so the dollar may have to “overshoot” its eventual 30
depreciation level in order to achieve a significant adjustment in trade flows in the short run.)
However, a sudden increase in interest rates could swamp the trade effects and cause (or worsen)
27 Testimony of Brad Setser before the House Budget Committee, Foreign Holdings of U.S. Debt: Is our Economy
Vulnerable?, June 26, 2007. Brad Setser is Senior Economist, Roubini Global Economics, and Research Associate,
Global Economic Governance Programme, University College, Oxford. Setser does not detail how much U.S. debt he
assumes China would sell to reach his estimate.
28 The extent that the dollar declined and U.S. interest rates rose would depend on how willing other foreigners were to
supplant China’s reduction in capital inflows. A greater willingness would lead to less dollar depreciation and less of an
increase in interest rates, and vice versa.
29 A sharp decline in the value of the dollar would also reduce living standards, all else equal, because it would raise the
price of imports to households. This effect, which is referred to as a decline in the terms of trade, would not be recorded
directly in GDP, however.
30 Since the decline in the dollar would raise import prices, this could temporarily increase inflationary pressures. The
effect would likely be modest, however, since imports are small as a share of GDP and import prices would only
gradually rise in response to the fall in the dollar.
a recession. Large increases in interest rates could cause problems for the U.S. economy, as these
increases reduce the market value of debt securities, cause prices on the stock market to fall,
undermine efficient financial intermediation, and jeopardize the solvency of various debtors and
creditors. Resources may not be able to shift quickly enough from interest-sensitive sectors to
export sectors to make this transition fluid. The Federal Reserve could mitigate the interest rate
spike by reducing short-term interest rates, although this reduction would influence long-term
rates only indirectly, and could worsen the dollar depreciation and increase inflation.
Some U.S. officials have expressed doubts that a Chinese sell-off of U.S. securities would cause
liquidity problems or have much of an impact on the U.S. economy. In January 2007, Secretary of
Treasury Henry Paulson was asked at a Senate Banking Committee hearing whether or not he was
concerned over China’s large ownership of U.S. debt. Paulson stated that the daily volume of
trade in Treasury securities was larger than China’s total Treasury securities holdings and
concluded: “given the size of our debt outstanding and the way it trades and the diversity and so 31
on, that’s not at the top of the list.” According to the Treasury Department, gross foreign
purchases and sales of U.S. marketable Treasury bonds and notes in 2006 were $11.0 trillion and 32
$10.8 trillion, respectively. In addition, the average daily trading volume by primary dealers of 33
all U.S. Treasury securities sold in the U.S. in 2006 was $524 billion.
In March 2007, Federal Reserve Chairman Ben Bernanke reportedly stated in a letter to Senator
Shelby that “because foreign holdings of U.S. Treasury securities represent only a small part of
total U.S. credit market debt outstanding, U.S. credit markets should be able to absorb without
great difficulty any shift of foreign allocations.” He also reportedly stated that “even if such a
shift were to put undesired upward pressure on U.S. interest rates, the Federal Reserve has the
capacity to operate in domestic money markets to maintain interest rates at a level consistent with 34
our economic goals.”
The likelihood that China would suddenly reduce its holdings of U.S. securities is questionable
because it is doubtful that doing so would be in China’s economic interests. First, a large sell-off
of China’s U.S. holdings could diminish the value of these securities in international markets,
which would lead to large losses on the sale, and would, in turn, decrease the value of China’s 35
remaining dollar-denominated assets. This would also occur if the value of the dollar were 36
greatly diminished in international currency markets due to China’s sell-off. Second, such a
move would diminish U.S. demand for Chinese imports, either through a rise in the value of the
yuan against the dollar or a reduction in U.S. economic growth (especially if other foreign
investors sold their U.S. asset holdings, and the United States was forced to raise interest rates in
31 Congressional Transcripts, Congressional Hearings, Senate Banking, Housing and Urban Affairs Committee,
Hearing on U.S.-China Strategic Economic Dialogue, January 31, 2007.
32 These figures include purchases of newly issued securities, as well as transactions executed in the United States
(buying, selling, and redeeming) of outstanding long-term U.S. Treasury securities (excluding nonmarketable Treasury
bonds), as reported by banks, securities brokers and dealers, and other entities in the United States. See Treasury
Department, Financial Management tables on capital movements at http://www.fms.treas.gov/.
33 Source: Securities Industry and Financial Services Association.
34 Reuters, Bernanke-China Holdings of US Debt Not Problematic, March 26, 2007.
35 Since there are many other holders of U.S. assets, it is possible that if China believed a decline in asset values was
imminent, it could minimize its losses by dumping its U.S. assets first, however.
36 Selling off U.S. dollar assets could cause the yuan to appreciate against the dollar, which would lower the value of
remaining U.S. assets since the assets are dollar-denominated.
response).37 The United States purchased about 30% of China’s total merchandise exports in
2007. A sharp reduction of U.S. imports from China could have a significant impact on China’s
economy, which heavily depends on exports for its economic growth (and is viewed by the 38
government as a vital source of political stability). Finally, any major action by the Chinese
government that destabilized (or further destabilized) the U.S. economy (whether deliberate or
not) could provoke “protectionist” sentiment in the United States against China.
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 39
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 40
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 41
investment rates, all else equal, which would reduce long-term 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 42
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 43
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
37 In addition, if a “dollar collapse” occurred, U.S. imports from other major trade partners would decline, which could
slow their economies. This in turn could weaken their demand for Chinese products.
38 Although a falling dollar may harm China’s short-term growth via reduced Chinese exports (and export sector-
related employment), it would also improve China’s terms of trade with the United States, raising China’s overall
consumption since it could now spend less to acquire the same amount of American goods (which would also create
jobs in other sectors of the economy because of increased consumer purchasing power).
39 Nations (such as the United States) that fail to save enough to meet their investment needs must obtain savings from
other countries with high savings rates (such as China). By obtaining resources from foreign investors for its
investment needs, the United States is able to enjoy a higher rate of consumption than it would if investment were
funded by domestic savings alone. The inflow of foreign capital to the United States is equivalent to the United States
borrowing from the rest of the world. The only way the United States can borrow from the rest of the world is by
importing more than it exports, which produces a trade (and current account) deficit.
40 The current account deficit rose from $389.4 billion in 2002 to $811.5 billion in 2006, and as a percent of GDP, it
increased from 4.4% to 6.1%, respectively. The Economist Intelligence Unit estimates that the current account deficit
fell to $739 billion in 2007 (5.3% of GDP).
41 See CRS Report RL33186, Is the U.S. Current Account Deficit Sustainable?, by Marc Labonte.
42 See Council of Economic Advisors, Economic Report of the President, The U.S. Capital Surplus, February 2006, p.
43 In November, the Chinese government announced it would implement a two-year $586 billion stimulus package,
mainly dedicated to infrastructure projects.
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.
Some U.S. policymakers have expressed hope that China will increase its U.S. debt holdings in
order to help the Federal government pay for its financial rescue plan and future stimulus 44
packages. But others have expressed concern that becoming more reliant on Chinese purchases
of U.S. debt would increase China’s political leverage over the United States and may make it
more difficult for the United States to induce China to appreciate its currency more quickly and to
make other needed reforms to its economy.
Wayne M. Morrison Marc Labonte
Specialist in Asian Trade and Finance Specialist in Macroeconomic Policy
email@example.com, 7-7767 firstname.lastname@example.org, 7-0640
44 See CRS Report RS22984, China and the Global Financial Crisis: Implications for the United States, by Wayne M.