Why has China increased US debt holdings?

China increased its holdings of U.S. Treasury securities by 200 million U.S. dollars last November. The country held nearly 1.2 trillion U.S. dollars' worth of Treasury securities by the end of last November, and remained the largest single foreign holder of U.S. government debt, according to a Treasury International Capital report released by the U.S. Treasury Department on Jan. 16. China also increased U.S. debt holdings by 16.3 billion U.S. dollars last October, revised data revealed.

Experts said that increases or cuts in China's U.S. debt holdings are normal market behavior, and should not be interpreted politically.

Market demand for U.S. government debt rebounds

Despite the drop in U.S. Treasury yields, most foreign creditors increased their holdings of U.S. government debt last November. According to data from the Department of the Treasury, foreign holdings of Treasury securities rebounded last November, during which foreign governments and private investors bought a net total of 26.4 billion U.S. dollars' worth of Treasury securities, hitting a three-month high. Net foreign holdings of long-term Treasury bonds increased 52.3 billion U.S. dollars last November, after decreasing 1 billion U.S. dollars last October

China and Japan are the largest and second largest foreign holders of U.S. government debt. The U.S. debt held by the United Kingdom and Caribbean countries increased the most last November.

China mainly increased holdings of Fannie Mae and Freddie Mac bonds. Data revealed it increased net holdings of long-term Treasury bonds by 894 million U.S. dollars last November.

A breakdown of the holdings showed that it reduced holdings of long-term Treasury bonds by 902 million U.S. dollars, increased Fannie Mae and Freddie Mac bonds by nearly 1.1 billion U.S. dollars, increased holdings of corporate bonds by over 1.2 billion U.S. dollars, and reduced holdings of corporate stocks by 520 million U.S. dollars.

Analysts attributed the rebound in foreign demand for U.S. government debt to the risk avoidance awareness raised by the global economic slowdown and the U.S. policy of quantitative easing.

Gennadiy Goldberg, an economist at TD Securities in New York, noted that the Federal Reserve announced in September that it would buy 40 billion U.S. dollars in mortgage securities each month, which temporarily reduced foreign demand for U.S. government debt. Most foreign investors then turned their eyes to mortgage securities.

Second best option

China, the largest foreign holder of U.S. government debt, started reducing its U.S. debt holdings in 2011 due to the drop in Treasury yields. The country reduced U.S. debt holdings by around 100 billion U.S. dollars in November 2011, and increased or cut the holdings by billions of U.S. dollars in the following year.

"The increase in China's U.S. debt holdings at the end of last year is normal market behavior," said Sun Huayu, a professor at Jinan University's International Business School. "China posted a large trade surplus last year, which increased its foreign exchange reserves."

China's trade surplus hit a three-year high of 231.1 billion U.S. dollars last year, up over 48 percent from the previous year, according to statistics from the General Administration of Customs.

Haitong Securities noted that the country's trade surplus rose more than expected last year. The monthly trade surplus started in March, and fluctuated around 20 billion U.S. dollars in the following months, higher than the historical average.

Due to safety and liquidity needs, a major part of the increased foreign exchange reserves have been spent on U.S. government debt.

Prof. Sun said that safety overrides returns when it comes to foreign exchange reserves because higher returns mean higher risk. Compared with euro and yen assets and those of emerging markets, U.S. government debt is safer and has higher liquidity. Therefore, it is a second best option for China to increase U.S. debt holdings.