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China Has Few Options But To Stick With U.S. Treasury Bonds

August 7, 2011

For now…

Beijing does have its own worries, like soaring inflation and housing prices and an overheating economy. Policymakers are also trying to deal with the accumulation of huge foreign exchange holdings. Trade and current account surpluses have helped China accumulate the vast foreign exchange reserves. It has invested much of those reserves in U.S. Treasury bonds, largely because the U.S. market has long been considered the safest and most liquid bond market in the world.

Analysts say that China can also buy bonds in the European and Japanese markets but that those two markets are not big or liquid enough to absorb China’s fast-accumulating foreign exchange reserves.

Beijing policymakers are discussing ways to diversify the country’s foreign exchange holdings away from dollars and also how to encourage Chinese companies to invest some of the foreign reserves overseas.

But because China has about $3 trillion in foreign exchange reserves, there are few places big enough to invest those holdings safely outside of U.S. Treasurys, even though it looks as if they may lose value.

Analysts say that if China pulled back from buying Treasurys, the dollar would weaken and America’s borrowing costs would rise sharply, but that would also hurt China’s existing holdings.

And so until China can find a way to slow its accumulation of dollars or find alternatives, it is likely to be the largest buyer of Treasurys.

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