China has Stopped Buying U.S. Government Debt

The U.S. Treasury Department surveys banks, companies, and governments who own U.S. federal debt on a monthly basis and produces a public report. The detail and accuracy of the report have increased over the years and we now have a decent understanding of who owns U.S. debt and how those positions change over time. The most recent report available, with data through September 2011, highlights an interesting shift in foreign holdings of U.S. debt – China is no longer adding to its position in treasuries, and hasn’t in over a year.

The most consistent trend in the treasury market over the last decade, other than the increasing size of the market, is China’s appetite for treasuries. The U.S. trade deficit with China leaves the Chinese government in possession of large quantities of U.S. dollars. China must then invest these dollars into interest bearing assets, and treasuries have been one of their favorite destinations. China’s treasury holdings increased from $61 billion in 2001 to $1.15 trillion this year. The country became the largest foreign holder of U.S. debt and by the end of 2010 owned 13% of outstanding federal debt held by the public. But over the last 12 months, for the first time in a decade, China stopped adding to its position. While they continue to roll over some maturing positions, overall holdings are flat.

What has changed? This doesn’t appear structural, as the China-US economic relationship is substantially the same, with increasing US deficits offering ample buying opportunities and the large trade deficit still sending US dollars to China every month. It’s also not a diversification strategy, as China’s sovereign investments are well diversified with treasuries accounting for one third of assets. Rather, it appears China has reached its appetite for U.S. government debt, at least in the short run. This raises key concerns for the U.S. as the country needs to sell large amounts of additional debt over the next decade. While the current economic crisis has increased global demand for treasuries, losing one of the largest buyers of new debt will have an impact.