Opinion

It's time to stop treasuries being such risky business

By Dong Xiaojun (China Daily)
Updated: 2010-05-20 12:48

China must urge the United States to find solutions to the risks of China holding US Treasury debt at the upcoming Strategic and Economic Dialogue (SED), as possible dollar depreciation in the future would add to the woes of the nation.

The US Treasury Department reported on Monday that China's holdings of US bonds rose to $895.2 billion in March from $877.5 billion in February. The $17.7 billion increase was the first by China, also the largest holder of the US treasuries, since last September.

Although it is hard to say whether the United States will lobby China on buying more treasuries during the upcoming China-US SED, due to take place on May 24-25, an undeniable truth is that China is under pressure by holding such large volume of US treasuries, especially considering the continued depreciation of the dollar.

The SED provides China with a good opportunity to urge the US to take some concrete measures to help China reduce the risks of holding Treasury bonds.

From 2001 to 2009, the dollar has depreciated by 40 percent, and only in the eight months from March to November 2009, the dollar fell 25 percent. China has undoubtedly incurred huge losses from this.

By the end of the third quarter of 2009, China's foreign exchange reserve rose to $2.27 trillion, about 70 percent of which is in US dollars, or $1.6 trillion. It is estimated that from 2002 to 2007, China lost $859 million, $403 million, $8.54 billion, $25.39 billion, $61.84 billion and $106.7 billion respectively, as a result of the dollar depreciation.

However, the depreciation has brought benefits to the United States. According to a study by the US Federal Reserve, the US economy grew 1.2 percent when the dollar fell by 10 percent. From 2002 to 2007, the US could have gained $1.3 trillion from the depreciation of the dollar.

Therefore, during the dialogue, China must inform the US of the losses it incurred from holding treasuries, in a bid to encourage the US to compromise on other issues, such as transferring high-tech technologies used for reducing environment pollution to China.

It is estimated that China needs over 60 technologies to cut carbon emissions as expected, among which over 40 are currently beyond the nation's grasp.

Besides, the Chinese government should also present some proposals to the US on helping the nation avoid the risks of possible dollar depreciation and inflation.

From a long-term perspective, the dollar is set to depreciate. Nobel economics' laureate Paul Krugman pointed out that dollar depreciation would lead to losses of up to 20 to 30 percent of China's investment in bonds.

China could demand the US issue "Obama bonds", a new type of "Carter bond" at the time when the US is in urgent need of funding to recover from the financial crisis.

"Carter bonds" are a series of Treasury bonds issued by the US in 1978 to prevent a fall in the dollar, named after then US President Jimmy Carter. Different from typical Treasury bonds, which are denominated in dollars, Carter bonds were denominated in non-dollar currencies.

"Obama bonds" would help nations holding treasuries avoid risks, diversifying their assets and also help the US shift from a high-spending and high-debt growth model.

And the US government has no reason to say no to the "Obama bonds" as these would send a clear signal to the market that the US is determined not to let the dollar depreciate further.

The US could issue bonds denominated in euros, sterling, yen and Swiss francs, which would help China diversify its foreign exchange holdings, or the US could entrust the International Monetary Fund to issue bonds that are denominated in yuan, which would promote the internationalization of the yuan, or China could ask foreign enterprises in China to issue yuan-denominated bonds.

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And apart from the "Obama bonds", China could also urge the US to change the existing Treasury bonds into treasury inflation-protected securities (TIPS) to avoid inflation risks.

In August 2009, the US pledged to continue to issue TIPS to China, but the depreciation risk for the existing $800.5 billion bonds China bought before that date remained huge, especially when inflationary expectations picked up globally.

China could change the bonds into TIPS to head off asset bubble risks, as pegging the yield rate of US treasuries with its inflation rate would effectively help China prevent the value of its foreign assets from shrinking. TIPS currently accounts for 50 percent of total treasury bonds issued by the US government.

Dong Xiaojun is a professor at the Economics Research Center with the Chinese Academy of Governance