If most members of Congress were asked how much China has invested in the U.S., they would respond with about $900 billion. This is a notable sum. Yet it’s too low by $1 trillion and possibly more. If many participants in financial markets were asked about Chinese investment in the U.S., they would fret over the possibility of disinvestment. This seems perfectly reasonable. At present, though, it’s essentially impossible.
The Department of the Treasury just issued its preliminary report of foreign holdings of American securities. It puts Chinese investment in the U.S. at $1.61 trillion, including $1.1 trillion in Treasury bonds, as of June 30, 2010. These are not entirely accurate, but are far more accurate figures than given in the unrevised monthly Treasury report of foreign holdings used by Congress and the media alike. To illustrate: the total for Chinese Treasury holdings was previously $844 billion. Upon revision, it is now $1.11 trillion.
There are two obvious problems. First, the large amount of U.S. dollar assets held by the PRC is obscured by poor numbers. Second, there is widespread misunderstanding of why China holds dollars. It does so due to its own balance of payments system. Until the PRC changes its own rules – which it so far has declined under intense foreign pressure – it has no choice but to buy. Disinvestment cannot occur.
Flawed American Numbers
Congress and the public rely on Treasury’s monthly series on major foreign holders of its bonds, which previously put China’s total at $892 billion at the end of 2010. This was misleading in at least four ways:
1) It obscured over $250 billion in Chinese purchases made via Britain, Hong Kong and offshore sources such as the Cayman Islands.
2) It excluded at least $300 billion in agency bonds purchased from Fannie Mae and Freddie Mac held through the end of 2010.
3) It excluded over $125 billion in purchases stocks and short-term debt.
4) It excluded dollars held outside securities, such as in Chinese and other banks.
Treasury’s annual report addresses the first three problems. It includes agency debt. In the annual report, Treasury uses a more complete survey than the monthly report. It traces some of the indirect buying of Treasuries the PRC does, through Britain especially. The annual report also includes estimates of other Chinese holdings, as in the U.S. stock market. The headline figure of $1.61 trillion is a much more accurate number than the $892 billion.
Unfortunately, the annual survey is not frequent enough. It is eight months out of date upon release and 20 months out of date before being revised. Just as with the inaccurate monthly series, the annual report cannot be used to ascertain whether China is currently buying or selling American bonds. Other limitations of the annual survey include failure to attribute all indirect buying – for example, the Caymans were said to invest $732 billion. It does not measure simple bank deposits denominated in dollars, even in American banks. These are not as important as investments but may involve large sums.
Flawed Chinese Numbers
Chinese figures contain additional information. They also shed light on the true nature of the PRC’s purchases: these are not choices to be unraveled at any time, they are the unavoidable outcome of China’s balance of payments regime.
China’s official foreign exchange reserves stood at $2.85 trillion last year. Remarkably, total Chinese foreign currency holdings are even larger than that. The domestic banking system appears to have held almost $400 billion more in foreign exchange at the end of 2010, though no such figure can be confirmed. A low figure for the PRC’s total foreign exchange holdings is therefore better estimated at $3.25 trillion.
A higher estimate, also using official data, puts total foreign exchange in the banking system at over $3.4 trillion. Sovereign wealth fund China Investment Corp. was originally granted $200 billion in foreign exchange, though the present distribution of its assets is unclear. Finally, deposits held overseas by Chinese entities outside the central government are excluded. It is possible total Chinese holdings exceed $3.6 trillion.
There is no official Chinese figure for total holdings, nor for the dollar’s share in those holdings. The lowest estimate of the dollar share is about 58%. The highest is an official figure on the dollar share of the PRC’s debt, 72%. Chinese dollar holdings therefore most likely ranged from $1.9 trillion to $2.6 trillion by the end of 2010. A recent estimate by Federal Reserve Chairman Bernanke of $2 trillion, which seems to have surprised the Congress as high, may in fact be too low.
Beijing’s True Options
This may be apocalyptic for some. In other words, if $900 billion in Chinese purchases was a sign of Chinese influence, $2 trillion is far worse. In fact, the huge figure indicates the opposite: the PRC holds all those dollars because it has no choice.
China cannot spend foreign currency at home. Because the state controls the entire financial system and foreign currency cannot be invested overseas by citizens, any attempt to spend foreign currency at home – for instance to build hospitals — returns the funds to the state. When pushed, senior Chinese officials acknowledge this.
Foreign currency in banks, either to finance commercial activities or simple deposits, accounts for some holdings outside official reserves. However, that leaves perhaps $3 trillion invested overseas. The number is soaring; the balance of payments surplus has averaged almost $400 billion annually the past four years. This is after the PRC buys all its oil, iron, gold, and so on. Outside bonds, China’s outward investment is $55-60 billion annually — sizable but only 15% of the required outlay. This includes all purchases of stocks and other assets foreign countries have allowed.
There is no European bond market and most national euro-denominated bond markets are underdeveloped. The PRC’s holdings of Japanese government bonds are comparatively minor and may be shrinking. Almost all other bond markets are too small. Only one market is large enough to absorb all that money.
If China were running $150 billion annual surpluses, say, it could avoid investing in the U.S. If it changed its balance of payments rules to greatly loosen state control, as Washington wants, it could avoid investing in the U.S. At $400 billion annually and unable to use the money at home, the PRC must allocate huge amounts to American bonds. The amount is so large because there’s nothing else for China to do.
Conclusion: Better Data Make Better Policy
There is far more Chinese money in the U.S. than widely understood. Yet no disaster has occurred. This is because of the depth of American financial markets but also because the PRC cannot disinvest under conditions it clings tightly to – huge external surpluses and rigid balance of payments rules. The actual lesson of $1.6 trillion in June 2010, and counting, is no Chinese financial influence over America.
Mistaken impressions are caused in part by the incomplete picture. Further, when conditions finally change, Chinese funds will need to be monitored better than is done now. Most important, the PRC is not just pegged to the dollar, it is dependent. Addressing that dependence will yield a more open China.
1) The annual Treasury survey is a weighty undertaking but perhaps could be made semi-annual. If not, a more limited quarterly or monthly survey superior to the monthly foreign holders series should be created. Congress needs better information and Treasury should provide it.
2) The U.S. should encourage the PRC to address dollar dependence in mutually beneficial fashion. Led by Treasury and including the Department of State and the White House, the U.S. should offer technical assistance and extensive financial cooperation in the face of any instability. This could be coupled with reciprocal Chinese cooperation in other areas.
Chinese investment is far more extensive than commonly thought, because the PRC has no choice but to pour hundreds of billions in excess foreign exchange into the U.S.
