April 24, 2014 1:00 pm JST

A $700 billion Chinese mystery

YOICHI TAKITA, Nikkei senior staff writer

TOKYO -- Where did China put its holdings of U.S. Treasury bonds?

     One might ask this question after listening to Liu Mingkang, who served as the first chairman of the China Banking Regulatory Commission, give a speech on April 16 in Washington.

     China is using U.S. government bonds for half its foreign currency reserves, according to Liu. China's foreign currency reserves stood at $3.95 trillion as of the end of March 2014, indicating that the value of the country's holdings of U.S. government bonds should be $1.97 trillion or so.

     The value of U.S. government bonds held by foreign investors was $5.88 trillion as of the end of February, of which 33.6% are believed to be held by China. Most U.S. governments bonds held in China belong to authorities. That means Chinese authorities should hold 48.5% of the total $4.06 trillion U.S. government bonds held by foreign authorities.

     U.S. Treasury Department statistics show this is not the case. The data shows the value of China's holdings of U.S. government bonds was $1.27 trillion as of the end of February. According to Liu's remarks, the figure should be $1.97 trillion. About $700 billion is missing. Did Liu pump up his figures? That is unlikely.

     A difference of as much as $700 billion between Chinese remarks on bond holdings and U.S. statistics has appeared, which is unusual. The U.S. Treasury Department cannot be happy about this.

Solved?

There are two possible explanations of the missing $700 billion.

     China might be using nominees' accounts. The country is believed to hold Japanese stocks under the names OD05 Omnibus and The Bank of New York, Treaty Jasdec Account. With this in mind, the country may hold U.S. government bonds under different names.

     A second possibility is that China is using custodial accounts in a country other than the U.S. to hold bonds. Some financial industry insiders suspect that Euroclear, a Belgium-based international clearing and settlement organization, may be used by the Chinese.

     Belgium's holdings of U.S. government bonds have moved in an unusual way. The value of Belgium's holdings of U.S. government bonds was $341.2 billion as of the end of February, the third largest after China and Japan. The figure jumped by as much as $174.4 billion in the six months.

     Belgian investors in the six months through February behaved as they normally do in terms of their investments in U.S. bonds. But perhaps foreign investors who purchased U.S. government bonds have selected Belgium as a place to store them. If that is the case, it is natural to think China is among the foreign investors. China appears to be putting part of its U.S. government bonds in Euroclear.

Mind games

Foreign countries usually put their holdings of U.S. government bonds in custodial accounts at the Federal Reserve Bank of New York. Why would China depart from the norm? Maybe the country does not fully trust the U.S. government.

     The U.S. has frozen assets held in the U.S. by top Russian officials and companies, as "economic sanctions," because of rising tensions in Ukraine. The Chinese government must be concerned, because it could be a sanctions target further down the road.

     China's U.S. government bond holdings are worth close to $2 trillion. A missing $700 billion are somewhere out of U.S. reach. Tensions between the U.S. and China are not limited to diplomatic and security matters. Another battle is ongoing in the U.S. government bond market.