Washington’s financial sanctions on Russia for invading Ukraine have raised concern in China over its large exposure to US government bonds, although experts say there is no real alternative for the country to invest its foreign exchange reserves.
In recent weeks, former central bank adviser Yu Yongding and former vice-chairman of the Bank of China, Wang Yongli, have issued warnings about the effect that Western sanctions could have on China’s investment in foreign securities, amid US threats of “consequences” if Beijing helps Russia evade sanctions.
“If China also encounters similar sanctions against Russia, its overseas assets may even face the danger of turning to zero,” said Yu, a prominent Chinese economist, in a blog post last week.
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Russia’s invasion of Ukraine on February 24 triggered a barrage of sanctions from the US and its allies that have included removing some Russian banks from the international financial messaging system Swift, which is used to transfer money across borders.
The foreign currency reserves of Russia’s central bank have also been frozen, causing the rouble to plunge more than 20 per cent initially, though the currency has since stabilised after Russia imposed harsh capital controls to prevent outflows.
A country like China that runs a trade surplus has to invest in foreign assets and there are few other choices but US bonds, said Michael Pettis, a professor of finance at Peking University and a veteran China observer.
“By implementing the sanctions, Washington has shown that control over the global payment system gives it an enormous amount of power,” he said. “Countries like China, Iran, Russia and Venezuela who are very concerned with the exercise of that power now have a greater incentive to hold something other than the dollar. But that’s all it is … what else can they hold?”
China, which is known as the workshop for the world, has been accumulating foreign income from its exports since joining the World Trade Organization in 2001.
Last year, China’s trade surplus with the rest of the world rose 29 per cent from a year earlier to US$676.43 billion – the highest since records began in 1950.
While China does not disclose where it parks its foreign trade revenue, a significant portion has been invested in US government bonds.
In January this year, China held US$1.06 trillion worth of US treasuries, making it the second largest holder behind Japan, according to the US Treasury.
Based on US Treasury data, US government bonds account for about a third of the value of China’s overall foreign exchange reserves, which stood at US$3.22 trillion in January, according to exchange regulator State Administration Of Foreign Exchange.
“China’s national foreign exchange reserves are mainly the currencies of developed countries such as the US dollar and the euro, and are also mainly stored in developed countries such as the United States and Europe. This outcome is not optional,” Wang said in an op-ed published in Caixin magazine late last month.
“This also means that once the relationship with the United States and Europe breaks down, the security of [China’s] foreign exchange reserves will be greatly threatened,” Wang said.
China has refused to condemn Russia’s invasion of Ukraine and said it would continue to maintain trade and economic cooperation with both countries.
A diplomatic source in Beijing said that China is concerned over the US threat of “consequences”, as well as what type of economic engagement with Russia might trigger sanctions.
“The red line is arms sales. The US is playing with ambiguity,” said the source. “They believe that Europe may not be on board to sanction [China].”
China has been reducing its exposure to US government bonds since 2015, although it has not been able to find a similar replacement. Investing in euro-denominated securities and Japanese government bonds are also not good alternatives , Pettis said.
“Europe needs to acquire assets abroad and it would not welcome the consequence of too much money shifting out of the dollar into euros because that would force up the value of the euro and make it difficult for the Europeans to run current account surpluses, which they have to run, like China, because domestic demand is too weak,” he said.
“Japan also relies on a current account surplus to absorb domestic demand and we have seen it before, if you buy too much yen, the Japanese get angry, so you can’t really do that.”
While developing countries would welcome China’s investment, such exposure is deemed too risky, Pettis said, and the same also applies to gold and other commodities, as reserve assets should be in relatively stable investments during turbulent times.
Both Yu and Wang said Beijing needs to consider countermeasures if the US and Europe impose sanctions on Chinese investment overseas.
“Overseas assets and liabilities should be balanced, especially not to hold too many US dollar assets … to have the ability to come up with equal countermeasures if needed,” Yu said.
Wang said that China should continue its economic and financial opening to the world, encouraging foreign investors to hold more Chinese assets, to form a “stronger integration of interests”. He said the US and Europe cannot “afford” to impose sanctions on China similar to those on Russia or North Korea.
“It is difficult for the United States to completely decouple from China, and freezing or even confiscating China’s reserve assets can only be an extremely rare crazy outcome,” Wang said.
This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP’s Facebook and Twitter pages. Copyright © 2022 South China Morning Post Publishers Ltd. All rights reserved.
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