China is no longer the biggest foreign creditor to the US government, according to the latest data released by the US Treasury Department, a change that could weaken Beijing’s position in negotiating with the administration of Donald Trump.

China has reduced its holdings of US Treasury bonds in recent months to raise funds to mitigate capital flight and defend its currency, and is expected to keep doing so now that a rate increase by the US Federal Reserve has started a new round of yuan depreciation.

China cut its holdings by US$41.3 billion in October and a total of US$127 billion in the past six months, the US Treasury Department said on Thursday. It now holds US$1.12 trillion, giving the No 1 title to Japan, which sold off less last month.

“US monetary policy has exerted great pressure on foreign central banks because of the globalisation of financial markets,” said Tim Condon, chief Asia economist for ING.

The yield for benchmark 10-year US Treasury notes has risen to a nearly three-year high of 2.6 per cent as foreign investors, mainly central banks, have reduced their positions by hundreds of billions of dollars this year.

Beijing’s real exposure to US treasuries might be bigger because it uses proxy holders. It has never made its holdings of US government debt public, guarding the composition of its US$3 trillion in foreign exchange as a state secret.

However, the yielding of the position of top foreign creditor to Japan could still make a psychological difference in Beijing’s dealings with Washington.

US president-elect Trump’s earlier remarks about imposing a punitive tariff on Chinese products, his labelling of China as a currency manipulator, and his comments about abandoning the one-China policy with regard to Taiwan have already created headaches for Beijing.

The Fed’s interest rate increase and talk of further rises next year are translating into fresh pressure on the yuan.

Beijing had to sell US treasuries, the most fluid assets in its portfolio, “to raise funds to meet the growing domestic demand for US dollars and defend the yuan exchange rate”, said Han Huishi, a forex analyst with China Construction Bank. “It will continue in coming months.”

Uncertainties about the US are likely to be a key reason for the Politburo to prioritize stability in next year’s economic plan.

Source:  South China Morning Post - Dec 16, 2016     Aurthor:  Frank Tang