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Pragmatic Capitalism

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Foreign Central Banks

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Why do the central banks of europe, china, and japan hold so much U.S. gov’t debt? Are they doing this to manipulate their currencies, drive exports, or something along those lines? If foreign central banks sold off their U.S. gov’t bonds, what should the results be for U.S imports/exports and the value of the U.S dollar?

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Posted by laskerfan12
Posted on 02/18/2017 3:58 PM
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Foreign central banks hold so much US government debt because it is the only place they can get a risk free return on their dollars. If we buy something in China paid for with US dollars, the local Chinese company heeds to convert the dollars into yuan to pay local expenses. The dollars end up in the Chinese central bank. They could uses the dollars to buy oil or some other asset but eventually those dollars end up in the US central bank held as US debt. Dollars stay in the dollar zone, yen stays in the yen zone, etc. If any foreign government wants to sell US debt, they must first find a buyer of the debt. So, in that case, the amount of debt held is the same, but the holders are different. They can always find a buyer but as the last resort, the Federal reserve would buy it. The Federal Reserve is holding something like 40% of all US debt today as it is. China has been selling its US debt and buying yuan to try and keep their currency from falling as there is a lot of capital flowing out of China.

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Posted by John M. Wilkins
Answered on 02/19/2017 12:46 PM
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    All central banks hold FX (in cash and credit form) to manage their currencies. US Treasuries are at the top of the “credit ranking” scale and are thus a good choice.

    In addition, there are various historical reasons why USD ended up as the “world’s reserve currency” after WWII. “Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System” by B. Eichengreen (https://www.amazon.com/Exorbitant-Privilege-Dollar-International-Monetary/dp/0199931097) is one good account. Once a currency gets entrenched this way, it is not easy to budge.

    A scenario whereby a major US debt holder like China or Japan would “sell off” US Treasuries is highly unlikely, because it would result in a massive loss to the seller as well.

    (Incidentally, China has just reversed their recent trend and become a buyer of US Treasuries again.)

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    Posted by vlad
    Answered on 02/19/2017 10:31 PM
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      This is usually the result of trade. Foreign govts hold a lot of T-Bonds because they obtain cash via trade and reinvest the cash in T-Bonds. There’s just not much else they can do with the dollars so the excess dollar flow results in a necessary capital account surplus that gets reinvested in some other dollar denominated asset.

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      Cullen Roche Posted by Cullen Roche
      Answered on 02/20/2017 12:54 PM
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        Oh, and selling the bonds isn’t necessarily a big deal. Don’t think of prices as being set by size players. Prices are set by the urgency of buyers and sellers. Having a lot of bonds to sell does not mean you’ll permanently alter the price. Having an extreme urgency to sell a lot of bonds could mean a substantial change in price however. Still, in the long-term the markets are a weighing machine so let’s say inflation drops and China is flooding the bond market with sales – what will happen? Well, China might put upward pressure on rates in the near-term, but in the long-term the lower inflation trend will dominate pricing and rates will fall.

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        Cullen Roche Posted by Cullen Roche
        Answered on 02/20/2017 12:57 PM
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