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China's American debt as a hedge for Taiwan
By: Vikrum Sequeira
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Yesterday I went to a talk at St. Edward's University about Asia and the international financial system. The speakers included Jennifer Amyx, professor of political science at the University of Pennsylvania, Harry Harding, professor of political science at George Washington University, Hugh Patrick, an economist who focuses on Asia, and a few other speakers.

I had the chance to ask the speakers a question and their responses were interesting. I asked:

Most observers explain China?s accumulation of U.S. Treasury bonds as a safe investment and a method of undervaluing the yuan renminbi vis-?-vis the U.S. dollar. I heard a theory stating that another reason why China would accumulate U.S. debt would be as a strategic hedge against the United States should Taiwan declare full independence. In other words, if Taiwan declares independence and the U.S. defends the island militarily, China would consider liquidating its debt, consequently destroying the dollar. Because the United States would not be able to pay off its debt, other countries may put a "run on the bank," which would essentially destroy the dollar. Thus, do you think Taiwan strategy has been a motivator of China purchasing U.S. debt?

Hugh Patrick stated that the Chinese Central Bank has accumulated dollars primarily for economic reasons, as China utilizes an export-led economic strategy. He believes that China is a "prisoner of the dollar."

Jennifer Amyx argued that we should look at the broader context, and noted that the Japanese Central Bank, for years, had the largest foreign exchange reserves in the world. Japan currently holds USD $1 trillion in foreign exchange and is the second-biggest holder of U.S. government debt.

I agreed with Amyx that we should look at the larger picture, but she glossed over the fact that Japan is the U.S.'s strongest ally in Asia and depends on the United States for military protection. While it is unlikely that China would liquidate its debt, it is far more unlikely that Japan would consider such an action.

Amyx interestingly stated that the Chinese dollar holdings represent a Chinese inability to manage the economy and recapitalize Chinese banks. It makes sense, as China is awash with foreign exchange earnings, yet does not invest those earnings back into the Chinese economy. Something has to give.

Harry Harding strongly believed that the People's Republic would not use its foreign exchange reserves as a weapon. He mentioned the fact that China uses a pegged exchange rate as a part of its developmental model and pointed to the 1956 Suez Crisis, in which Britain?s gold reserves dropped sharply and the French franc also suffered.

He also mentioned, "If China sells its debt, it will be a buying opportunity for other countries."

What interested Harding the most was the idea of rumors. Whenever there are rumors of Chinese sell offs, currency and stock markets rumble around the world.

While Harding?s statement about a "buying opportunity" makes sense, I think he may be overestimating the security of a U.S. Treasury investment. Yes, the Treasury bond is still probably the safest investment in the world, but it is not definite that it will hold that position forever. Also, just as the selling of Treasury notes could be a "buying opportunity," it could also, conversely, start a traditional run on the bank, with the U.S. suffering a massive financial crisis. Do you all have any ideas?

Also, a related question: does anyone know how much the Chinese Central Bank has invested in U.S. mortgage-backed securities?

Vikrum Sequeira is a blogger who maintains Vislumbres a blog that can be located at

Opinions expressed in his blogs are his own, and not necessarily reflect the opinions of or its affiliates.


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