Expert Zone

Chinese investment in US: $2 trln and counting

(The views expressed in this column are the author’s own and do not represent those of Reuters)

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:

More important than the yuan: Opening China’s capital account

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The entire global economy would benefit if the dollar-yuan exchange rate were driven by market demand. It would contribute to a U.S.-China economic relationship that is more balanced, more sustainable and more beneficial to people in both countries in a way that a government-ordered revaluation would not.

The Communist Party appears to believe that Chinese workers and companies cannot be competitive with a market-oriented exchange rate. In fact, the responsiveness of bilateral trade to the exchange rate is exaggerated in both the U.S. and the People’s Republic of China (PRC).

However, there is a genuine financial risk in allowing the yuan to move freely. China’s dollar holdings now exceed $2 trillion, so a 25 percent gain by the yuan against the dollar would reduce their yuan value by $500 billion. The PRC is finally addressing this issue by resuming balance-of-payments reform, including actions taken in the past few months. If extended, they would enable China to internationalise the yuan and reduce its extreme dependence on the dollar. To this point, though, Beijing has avoided the crucial steps.

The U.S. can help alleviate Chinese concerns and spur financial reform in the PRC. It would require American assistance — and insistence — on a schedule for capital account liberalisation.

Too Many Dollars

The PRC holds more dollar assets than is commonly believed. The U.S. Treasury’s series on major foreign holders of Treasury bonds puts the PRC’s total at $896 billion at the end of November 2010. This obscures hundreds of billions in Chinese purchases made via Britain and Hong Kong. It also excludes hundreds of billions in agency debt from Fannie Mae and Freddie Mac.