The US Treasury reported last week that in February Japan moved ahead of China and resumed its position as the largest foreign creditor of the US government, a position last held by Japan in 2008. In February Japan owned $1.2244 trillion of US debt, slightly above China’s $1.2237 position, according to official figures. Both countries’ reported holdings are lower than they were in January. Total positions probably are higher, particularly in the case of China, which is believed to have made significant purchases through intermediaries in London, Belgium, and other markets. Note that the third-largest holder in the Treasury table is Caribbean Banking Centers.
More important than this monthly change is the change over the past 12 months. Over that period China’s holding declined by $49.2 billion while Japan’s increased by $13.6 billion. The Chinese decline reflects the slowdown in the Chinese economy. The growth in China’s foreign exchange reserves, the world’s largest at $3.86 trillion in the fourth quarter of 2014, has slowed significantly. Furthermore, China has been diversifying its holdings, allocating more to foreign corporate bonds, equities, and even real estate.
The increase in Japan’s holdings is probably mainly a result of the monetary policies of the central banks of Japan and Europe, which have driven interest rates down, and of the United States, which has not driven rates as low and which is expected to raise rates sooner than the other two central banks. Currently the U.S. 10-Year yield is 157 basis points above the Japanese 10-year yield and 178 basis points above the German 10-year yield. Private and institutional Japanese investors are responding by moving funds into the US bond market. Contributing to this trend, the Japan Government Pension Fund has raised its allocation to foreign bonds from 11 to 15%. The prospect of further US dollar strengthening probably has been an additional factor. Japan’s total foreign exchange reserves, on the other hand, were not a factor, as they declined in 2014.
Some commentators have expressed concern about the slowing pace of foreign exchange reserve accumulation in China and that country’s policy of diversifying its reserves, which they argue could lead to a shortage of demand for US Treasury securities and a significant rise in yields. The experience with respect to Japan should reduce such concerns. The decline in China’s holding of almost $50 billion last year did not appear to disturb the market. The US Treasury market is and will remain for the foreseeable future the most liquid government security market. There are practical limits on the extent to which the Chinese or other governments’ authorities would wish to diversify out of US Treasury securities. The US dollar’s strength and the current yield advantage add to its attractiveness as a reserve currency and should continue to do so for some time to come.
Bill Witherell, Chief Global Economist