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Tom Holland

Last week, the US Treasury released data showing that China's holdings of US Treasury debt fell by US$11.5 billion in February.
Following the latest drop, China's pile of US Treasury bills and notes has now declined by US$62.4 billion since its high last summer, stoking fears that Beijing may be dumping its holdings of US government debt.
This so-called 'nuclear option' has been threatened repeatedly over the past few years by Chinese officials angry at everything from proposed US arms sales to Taiwan to US calls for retaliatory tariffs on imports from the mainland.
Their threats have raised concerns that any move by China to diversify its foreign reserves out of US Treasury debt and into other assets could  push long-term US interest rates up steeply and leave the US government unable to finance a budget deficit expected to climb to US$1.6 trillion this year.
Those concerns were sharpened in February when the US Treasury released data showing that Japan had surpassed China as the biggest holder of American government debt at the end of last year.
'China sells US$34 billion of US debt,' shrilled headlines in newspapers around the world, most of which took an apocalyptic view of the decline in Chinese holdings.
Unfortunately for their editors, the story was rubbish. Japan, as we now know, did not overtake China  as the largest owner of US Treasury debt. A revision to the data released a few days later showed that China retained its top slot by a considerable margin.
True, China's published holdings did decline in December, as they have in the subsequent months (see the first chart below).
But contrary to hundreds of media reports, that does not mean Beijing is actively selling its US Treasury debt.
 We can be confident of that, because if Beijing were selling treasuries in significant volumes, we would have seen a sharp rise in yields over recent months. As it is, yields have been pretty much range bound since last summer, when China's published holdings were at their height.
Far more likely is that China's reserve managers are merely adjusting their Treasury portfolio.
As the financial crisis erupted in 2008, Beijing, like other investors, sought safety in US Treasury debt. In particular, China's reserve managers ditched their holdings of agency bonds issued by Fannie Mae and Freddie Mac and bolted for the relative security of Treasury bills and the shorter-dated Treasury notes. So any decline in China's published holdings can easily be explained by the maturity of some of its shorter-dated debt.
Of course, it would be troubling if Beijing were not rolling over its maturing holdings.  But it is likely that China is still buying. The data released by the US Treasury only tells us the location of the buyer, not the nationality of the ultimate owner of the debt. So, for example, if Beijing were to buy US treasuries through a bank in Zurich, the buyer would show up as Swiss, not Chinese.
As a result, analysts reckon that Beijing's real holdings of US treasuries may be anywhere between US$100 billion and US$400 billion, greater than those revealed by the US government data.
What's more, it is noticeable how the decline in China's direct holdings of treasuries has been offset by an increase in holdings by institutions in Britain, which indicates that Beijing may have switched to buying treasuries through London banks in order to cover its tracks.
Yet even if Beijing were to stop buying, it is unlikely that the consequences would be as dire as many commentators have predicted. Contrary to market fears, Washington would still be able to fund its deficit.
The second chart below comes from Charles Dumas at Lombard Street Research, who points out that the total government deficits of the developed world are offset almost exactly by the combined private-sector surpluses of the rich countries together with emerging Asia's current-account surpluses.
If Asian central banks were to stop buying treasuries, it would imply a fall in the region's current-account surpluses. That in turn would indicate a downturn in private demand from the rich world, which would imply an increase in the private-sector surplus of developed countries. That surplus would have to be invested somewhere, most likely in US treasuries.
In other words, it is unlikely that China has stopped buying US Treasury debt, but even if it has, the US government will have little difficulty financing its deficit.
China's nuclear option is a dud.



Chill out, Beijing is not about to drop da bomb