The Treasury International Capital (TIC) data for June 2022 released by the U.S. Treasury Department on August 15 showed that U.S. debt held overseas has increased by USD 5.1 billion to USD 7.43 trillion in June. Among them, Japan's June holdings of U.S. debt rose by USD 12.6 billion to USD 1.2363 trillion. Yet, China’s (Mainland) holdings fell by USD 13 billion in June to USD 967.8 billion. Although the overall scale of overseas holdings of U.S. debt in Shanghai has basically remained stable, China has reduced its holdings of the debt for seven consecutive months, and its current holdings have reached a new low in 12 years. Since reaching a high of USD 1.3167 trillion in November 2013, China's holdings of it have generally shown a downward trend. In the past nine years, China has sold USD 335.9 billion of U.S. debt, a reduction of nearly 26%.

Will China's reduction in U.S. debt continue? Will there be liquidation to avoid financial sanctions? Is this a strategic shift in "de-dollarization"? In the current situation of increasingly tense U.S.-China relations and intensive strategic competition, these issues have made the scale of China's holdings of U.S. debt a window for the outside world to observe the competition between the two countries. Hence, China's continuous reduction of holdings has attracted more and more attention worldwide.

Researchers at ANBOUND noticed that in the long run, China's reduction in U.S. debt is directly related to changes in its foreign exchange reserves. In 2013, when China was at its peak in holding U.S. debt, its foreign reserves also reached a high of USD 3.82 trillion, and in 2014 it further rose to USD 3.84 trillion. Since then, with the reform of China's foreign exchange system and fluctuations in the RMB exchange rate, the scale of China's foreign exchange reserves showed a tendency to decline. In 2016, at one point it fell to about USD 3 trillion and then rebounded to USD 3.25 trillion by the end of 2021. Since the beginning of this year, under the influence of the Federal Reserve's tightening of the currency and the fluctuation of the RMB exchange rate, as of the end of June, the scale of China's foreign reserves was USD 3,071.3 billion, a decrease of USD 56.5 billion or 1.81% from the end of May. This was also a decrease of USD 178.9 billion from the end of last year. With the continuous decline of foreign exchange reserves, it is reasonable for China to reduce its holding of U.S. debt. Its purpose is to obtain U.S. dollar cash to assume the role of foreign exchange reserves, meet foreign exchange demand, and maintain exchange rate stability.

When the U.S. dollar is still the main international currency, it is also a common choice for most international central banks to use U.S. dollar assets as part of their foreign exchange reserves. On the one hand, this avoids the impact of exchange rate fluctuations on currency settlement; on the other hand, it can obtain relatively stable and low-risk returns. Currently, the tightening of the Fed’s policy has brought about mixed changes to dollar assets. The rise of the U.S. dollar index and the volatility of U.S. debt yields constitute short-term factors for the reduction of the debt holding for overseas official institutions. Some analysts pointed out that the recent inversion of U.S. debt yields is serious, with its risk increasing. Under high inflation, and the U.S. GDP has contracted for two consecutive months, meeting one of the common criteria for a technical recession, market worries are increasing day by day. Therefore, some countries, including China, opt to reduce their holding of U.S. debt, which is actually a risk-averse choice. It should be noted that the main holder of U.S. debt is the Fed, and the total holdings of foreign buyers are only 30%. Selling U.S. debt will not actually have a substantial impact on the U.S. economy, nor will it trigger a default on U.S. debt. Therefore, the argument that selling U.S. debt as a "financial weapon" to hit the American economy is invalid. In fact, the U.S. Treasury Department does not fully grasp the amount of debt officially held by China. Some central banks prefer to trade U.S. debt through third-party financial institutions, and it cannot be ruled out that Chinese officials adopt a similar trading model.

That being said, geopolitics is changing everything.

The intensification of competition between the U.S. and China is promoting the financial decoupling of the two countries, increasing the risk of China's holding of U.S. dollar assets. In particular, the growing geopolitical risks brought about by the conflict between Russia and Ukraine and the tension in the Taiwan Strait have complicated the matter. On the one hand, there is the tough stance of the U.S. on audit disputes that promotes the delisting of Chinese stocks from the U.S. stock market; on the other hand, the U.S. government is restricting American institutional investors from investing in certain Chinese companies. At the same time, a series of financial sanctions imposed by the U.S. on Russia have made China aware of the political risks of holding a large amount of dollar assets. As a matter of fact, the Russian side has also made long-term preparations in order to reduce the loss of dollar assets in the context of tense U.S.-Russian relations. In January 2014, when the Ukraine crisis broke out, Russia held USD 131.8 billion in U.S. debt, and in the spring of 2017, it held more than USD 100 billion. In 2018, Russia's total holdings of U.S. debt plunged again to USD 14.9 billion following new U.S. sanctions. That figure has continued to decline since then, to USD 10 billion in 2019, USD 6 billion in 2020, and USD 3.9 billion by September 2021, until only about USD 2 billion remains this year, almost near liquidation. In the face of worsening U.S.-China, China's moderate adjustment of the structure of dollar assets, including the gradual reduction of its holdings of U.S. debt, is expected by the market. Considering the scale of nearly USD 1 trillion of the national debt held by China, the reduction will not be a short-term process.

With the declining economic influence of the U.S. and its frequent sanctions through the financial settlement system in recent years, this has actually affected the credit of the U.S. dollar. Such a situation has created a long-term trend of "de-dollarization" around the world. Earlier this year, the International Monetary Fund (IMF) released a report showing that from 1999 to 2021, the share of dollar reserves held by central banks fell from 71% to 59%. According to the report, the decline in the proportion of the dollar did not lead to an increase in the proportion of traditional reserve currencies such as the euro, the yen, and the pound, but to an increase in the proportion of more non-traditional reserve currency assets, including the yuan. The share of non-traditional reserve currencies has grown from negligible levels at the beginning of the century to USD 1.2 trillion in 2021, rising to 10% of global reserve assets overall. At the same time, more and more central banks have begun to seek diversification beyond the dollar. The report defines countries with more than 5% of non-traditional reserve currency assets as "active diversifiers", and the number of countries in this category has reached 46 by the end of 2020. The IMF's report at the time also believed that the decline in the share of the dollar in international reserve assets was not the result of changes in exchange rate factors. In fact, statistics show that although the decline in the proportion of the dollar is consistent with the declining trend of the U.S. economic volume and foreign trade volume in the global proportion, the correlation with the dollar index is not exactly high.

Judging from the current trends in the development and change of the international monetary system, ANBOUND pointed out that the system is evolving from a singular currency system dominated by the dollar to a more localized and diversified currency system. The State Administration of Foreign Exchange (SAFE) disclosed in 2020 that in 1995, the dollar accounted for 79% of China's reserve assets, much higher than the international average of 59% at that time. However, in 2016, its share of the dollar reserve assets dropped to 59%, which is consistently lower than the international average of over 65% that year. With the global economy and trade becoming increasingly de-globalized, China's reduction in its holdings of U.S. debt is also for the purpose of diversification. Therefore, from a longer-term perspective, with China's economic growth and the improvement of the international status of the yuan, its reduction of the dollar assets will be a major trend.

Final analysis conclusion:

With China continuing to reduce its holdings of U.S. debt, this has drawn the attention of the world amid the intensification of U.S.-China competition. ANBOUND is of the opinion that this is not only a normal investment strategic operation, but also a manifestation of the increasing "decoupling" of the two countries. In the context of de-globalization, it is also a long-term trend for China to reduce its holdings of U.S. dollar assets and promote "de-dollarization".