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In March 2022, the United States officially entered a cycle of aggressive interest rate hikes, and after more than a year of persistence, this policy finally brought serious consequences. There has been turmoil in the U.S. banking industry, with the collapse of two large banks that were once ranked in the top 30 in the United States, Signature Bank and Silicon Valley Bank, triggering a chain reaction in the U.S. banking industry.
The Fed had to act in response to the situation, and they implemented a distorted policy that tried to strike a balance between balance sheet reduction and expansion. Even U.S. Treasury Secretary Janet Yellen has to admit that the collapse of Silicon Valley banks stems from the Federal Reserve's continued interest rate hikes, not technology companies.
However, despite the already severe liquidity crisis in the US banking sector, Yellen has been able to remain calm. At the same time, the potential default risk of U.S. Treasuries and China's massive sell-off of U.S. bonds have become a big problem that needs to be addressed urgently.
On January 19, 2022, the total size of the US Treasury Debt touched the statutory debt ceiling for the first time, reaching $31.4 trillion. By March 17, real-time data from the U.S. Treasury Clock showed that the total U.S. debt had exceeded $31.62 trillion.
The US Treasury had to be forced to halt new US debt issuance, and the US Congressional Budget Office had previously warned that if the debt ceiling had to remain unchanged, the US federal government would be in danger of defaulting on its debt between July and September 2023.
In this time of crisis, as the saying goes, the house leak coincides with overnight rain. The burden of the US national debt is getting heavier, the traditional strategy of borrowing new and old is no longer viable, and there is a debate within the US Congress about whether the debt ceiling should be raised. Meanwhile, China, the second-largest foreign holder of U.S. debt, is selling off U.S. debt, bringing its holdings to its lowest level since May 2009.
On March 15, 2023, the U.S. Treasury Department released its latest report on international capital flows. According to the report, as of January 2023, China's total holdings of U.S. debt were US$859.4 billion, down US$7.7 billion from the previous month, which is the sixth consecutive month of reductions, while the size of China's holdings of U.S. bonds has fallen by 34.1% in the past 10 years, and in 2022 alone, the reduction is as high as 16.6%.
There are two main reasons why China has significantly reduced its holdings of U.S. debt. First, the Fed's aggressive interest rate hike policy led to an increase in U.S. Treasury yields, which in turn caused U.S. Treasury prices to fall rapidly, which caused valuation losses for investors. This internal logic is easy to understand because the yield on U.S. bonds is inversely proportional to the price. U.S. bonds are fixed at face value and coupon rate at the time of issuance, but in the secondary market, their price and yield to maturity fluctuate according to market conditions. If the coupon rate of the U.S. bonds held by investors is much lower than the interest rate on newly issued U.S. bonds in the market, then their U.S. bonds will lose their attractiveness and will have to be sold at a discount. This leads to a loss of valuation because they sell at a price below face value. At present, the yield on U.S. Treasuries is generally around 4%, while the yield on U.S. bonds issued in 2020 is mostly below 1%. As a result, the price of U.S. Treasuries purchased before the rate hike is relatively high, and investors face potential valuation losses that they hope to recover by selling old bonds, buying new bonds, or looking for other investment opportunities.
On the other hand, the reason why China has reduced its holdings of US debt on a large scale is also due to the consideration of diversifying risks. In recent years, the United States' attitude towards China has become very unfriendly, and it has adopted a series of suppression and containment measures, including tariffs, technology blockade, sanctions against Chinese companies, etc. Some members of Congress even proposed confiscating China's US debt. In addition, the United States adopted severe sanctions against Russia after the outbreak of the Russian-Ukrainian conflict, and these wrong policy measures further eroded China's trust and patience with the United States.
Recently, the United States has once again brought China into the limelight when discussing the debt ceiling. Because the U.S. national debt has already hit the debt ceiling, the U.S. House of Representatives suspended the proposal to raise the ceiling and proposed a plan to "prioritize partial debt repayment." Under the plan, if the U.S. Treasury is no longer able to issue bonds, it should first use federal funds to pay off public debt and Social Security
Spending is blocked, while other types of federal debt are put on hold.
Recently, U.S. Treasury Secretary Janet Yellen spoke out during a hearing on the federal budget held by the U.S. Senate Finance Committee. She said the Republican plan to "prioritize partial debt payments" could make China one of the first countries to be paid. "I cannot give any assurance as to the technical viability of such a plan, which would be an exceptionally risky, untested practice that completely deviates from the normal reimbursement practices of federal agencies," Yellen said. ”
Yellen's argument has sparked widespread controversy because the plan is actually a form of debt default. Raising the debt ceiling and paying all bills is fundamental to the U.S. maintaining its strong credit rating. However, the US debt ceiling has never been strictly enforced since its birth and has been raised many times. Although the US Congress is currently in internal friction over whether to raise the debt ceiling, based on past experience, it is likely that a last-minute agreement will finally be reached. After all, U.S. Treasuries are about U.S. creditworthiness, and not raising the debt ceiling would mean an actual default on the debt, and whether you choose to prioritize or not pay it will not do any good for U.S. credit. Once a debt default occurs, like dominoes, falling one ring after another will lead to a total collapse.
As a result of raising the debt ceiling, the United States had to continue issuing new bonds to service old debts, thereby increasing the total size of the US national debt. However, this cycle must be changed. As the second-largest overseas buyer of U.S. bonds, China's best option is to limit increments and gradually reduce its stock, rather than massively increase its holdings of new U.S. debt. At the same time, China should also find new alternatives to preserve and increase the value of its foreign exchange reserve assets.
China's massive reduction of U.S. debt is not only for its own benefit, but also a response to America's irresponsible policies. The United States should seriously rethink its long-term fiscal policy to avoid a relapse into the debt ceiling crisis. In the global economy, countries are interconnected, so economic problems in any one country can have a significant impact on others. It was to be hoped that the United States Government would adopt responsible policy measures to maintain the stability and sustainable development of the international financial system. Otherwise, it will not only harm the interests of the United States itself, but also have a serious impact on the global economy.
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