China appears to be taking steps to diversify its holdings away from the U.S. dollar and may just have chosen a pretty good time to do it.
Longer term a meaningful diversification by China, which holds about a third of its $2.45 trillion currency reserves in U.S. Treasuries, is probably both inevitable and highly risky.
Inevitable, because China probably realises that, given the U.S.’s difficult fiscal and economic challenges it is not sensible to have its own fortunes tied so closely to its major client.
Risky, because wholesale sales of U.S. Treasuries by China would drive up U.S. interest rates and could spark panic selling in the dollar. That would undermine the U.S. economy, hitting demand for Chinese goods, fouling U.S./China relations and, not least, torpedoing China’s own accumulated wealth.
However, it seems, people have more important things to be scared of than Chinese portfolio sales, and are running headlong into Treasuries seeking safety from deflation and the threat of a recession. That is overwhelming any impact that China diversification is having on U.S. instruments, at least so far.