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Trade war

China shrinks US Treasury holdings to 2-year low

Lingering trade war fuels speculation of continued sell-off

Market observers speculate that China may retaliate against American tariff hikes by dumping Treasurys.   © Reuters

SHANGHAI -- China sold more American government debt than it bought in recent months, bringing the balance to its lowest in two years as the market speculates that Beijing would retaliate against Washington's tariff hikes by dumping Treasuries.

China sold $20.4 billion in Treasuries on a net basis in March alone, bringing the balance to $1.12 trillion at month's end, according to data from the U.S. Department of the Treasury. The debt holdings were at the lowest level since March 2017, and China last sold more than $20 billion back in October 2016.

In March, China held its National People's Congress and was in the thick of trade negotiations with Washington. It was well before U.S. President Donald Trump tweeted May 5 that tariffs on $200 billion of Chinese goods would jump to 25% from 10%. Opinion is split, even inside China, on the reason for the March selling spree.

Technical factors may play a major role in the decrease in holdings, according to Guodu Securities. Beijing might have temporarily sold off Treasuries to adjust the mix of maturities in its portfolio, for example. Major Chinese media outlets reported on the drawdown in Treasury investments Thursday, but with restrained framing. "China remains largest foreign holder of U.S. Treasuries," read an English-language headline from the official Xinhua News Agency.

The dollar's declining share of foreign-currency reserves around the world is starting to become a concern in Washington. An active move by China to reduce U.S. debt holdings would further complicate bilateral relations. Now is not the best time for Beijing to use the so-called nuclear option, such conditions would suggest.

China may be losing the financial capacity to buy Treasuries in the first place. Its current-account surplus has trended downward in recent years. The International Monetary Fund predicts China will fall into a deficit in the early 2020s.

China has generally recorded net monthly sell-offs since last September, with net purchasing only in February. If punitive tariffs are applied to all Chinese exports, the nation's earning capacity would weaken further.

China's foreign-currency reserves have hovered slightly below $3.1 trillion, while its gold reserves have increased 3% over the past year.

Beijing is not likely to purchase Treasuries at a substantial pace, raising the possibility of Japan returning as the top holder of U.S. debt.

The weaker yuan also factors into the dynamic. At the end of Thursday's trading day 4:30 p.m. local time, the currency was slightly weaker at 6.8821 to the dollar. The consensus is that deteriorating Sino-American relations are causing investors to dump yuan.

Selling dominated trading throughout the day after the U.S. Commerce Department said it would add Huawei Technologies to the list of entities effectively barred from receiving exports of sensitive U.S. technologies -- essentially banning the telecommunications equipment giant from procuring American parts.

China appears ready to tolerate a cheap yuan to an extent as a way to prop up exports and as a counterweight to U.S. pressure. The psychologically significant threshold of 7 yuan to the dollar is seen as a bargaining chip in the trade talks.

But a yuan that weakens too quickly could invite capital flight. A devaluation by Chinese authorities in 2015 triggered an uncontrollable outflow of capital. Beijing intervened by buying yuan and selling dollars, with Treasury sales believed to have supplied funds for purchasing yuan.

Even if Trump manages to deal a stinging blow to China, the impact on the Treasury yields and the yuan's value could blow back onto American soil. The choppy financial markets, including Wall Street, could challenge the White House's hard line.

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