China holds more U.S. debt than indicated

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Despite recent government reports that China’s holdings of U.S. Treasury debt declined during the second half of last year, the Asian economic giant almost certainly owns far more Treasury securities than official statistics indicate.

After peaking at $801.5 billion, China’s holdings of U.S. Treasury securities declined to $755.4 billion at the year’s end, dropping the communist power into the position of second-largest holder of Treasury debt after Japan’s $768.8 billion, official government data reveal.

But these numbers don’t tell the whole story.

“The U.S. Treasury data almost certainly understate Chinese holdings of our government debt because [the U.S. figures] do not reveal the ultimate country of ownership when [debt] instruments are held through an intermediary in another jurisdiction,” Simon Johnson, an economics professor at the Massachusetts Institute of Technology, told the U.S.-China Economic and Security Review Commission, a bipartisan forum established by Congress in 2000 to monitor the security implications of the U.S. economic relationship with China.

Mr. Johnson told the commission last week that “a great deal” of last year’s $170 billion increase in Treasury holdings by the United Kingdom “may be due to China placing offshore dollars in London-based banks” and then using the funds to purchase Treasury debt.

Mr. Johnson, a former chief economist for the International Monetary Fund, estimated that China owns about $1 trillion in U.S. Treasury securities, or nearly half the $2.37 trillion stock of Treasury debt held by “foreign official” owners.

The amount of U.S. debt held by China is even higher than that, said Eswar Prasad, an economist at Cornell University.

Under the widely held assumption that 70 percent of China’s $2.4 trillion in foreign exchange reserves is invested in dollar-denominated bonds, Mr. Prasad told the commission that China probably holds about $1.7 trillion in U.S. government debt.

That would include the more than $400 billion in debt issued by U.S. government agencies, such as Fannie Mae and Freddie Mac, whose obligations are liabilities of the U.S. government, Mr. Prasad said.

Derek Scissors, a China scholar at the Heritage Foundation, described as “unusable” the official U.S. government data on foreign holdings of Treasury debt.

China’s mercantilist policies generate “by far the world’s largest balance of payment surpluses” and contributed to China’s $453 billion increase in foreign exchange reserves last year — surpluses that “are too large to put anywhere other than the United States. No other country has financial markets capable of absorbing them,” Mr. Scissors said.

But the economists at last week’s hearing disagreed about how much leverage China’s creditor status commands over the U.S.

Maj. Gen. Luo Yuan told China’s state-run Outlook Weekly magazine last month, shortly after the U.S. detailed new arms sales to Taiwan, that China’s “retaliation should not be restricted to merely military matters” but also should be “covering politics, military affairs, diplomacy and economics.”

“We could sanction them using economic means, such as dumping some U.S. government bonds,” Gen. Luo said.

Michael Wessel, a member of the U.S.-China commission, began the hearing by noting that China, whose economy expanded by 10.7 percent during 2009, “emerged from the global recession stronger than ever, expecting its status as America’s banker to convey new political power.”

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