China Dumps U.S. Debt, Stirring Fears of Deficit, Higher Rates

Monday, 15 Mar 2010 09:33 AM

China retained its spot as the biggest foreign holder of U.S. Treasury debt in January although it trimmed its holdings for a third straight month.

The string of declines is likely to underscore worries that the U.S. government could face much higher interest rates to finance soaring budget deficits.

The Treasury Department said Monday that China's holdings dipped by $5.8 billion to $889 billion in January compared to December. Japan, the second largest foreign holder of U.S. government debt, also trimmed its holdings but by a much smaller $300 million to $765.4 billion.

Net foreign purchases of long-term securities, a category that includes government and corporate debt, totaled $19.1 billion in January, as net purchases of private corporate bonds fell by $24.8 billion, the biggest drop on record.

A month ago, Treasury initially reported that China had cut its holdings so sharply that it had lost its top spot as America's largest foreign creditor, a position it had held since its holdings overtook Japan in September 2008.

However, 10 days later, Treasury released its annual update of the figures. The revised data showed that China, while reducing its holdings, still retained the top spot.

The decline in Chinese holdings is coming at a time of increased tensions between the two nations.

Chinese Premier Wen Jiabao on Sunday rejected American pressure on China to allow its currency to rise in value against the dollar, saying such efforts amounted to a kind of trade protectionism.

The Obama administration is hoping China will resume allowing its currency to rise in value against the dollar as a way of trimming the huge trade gap between the two nations. A cheaper dollar would make American products cheaper in China while making Chinese goods more expensive for American consumers.

Treasury's latest report on international capital flows showed that foreign holdings of Treasury securities increased by $17 billion in January to $3.71 trillion.

While China and Japan decreased their holdings, oil exporting countries boosted their holdings to $218.4 billion, up from $207.4 billion in December, and holdings of Treasury securities in Great Britain rose to $206 billion, up from $178.1 billion.

Economists say that unless foreign demand for U.S. Treasury debt remains strong the interest rates that the government has to pay for that debt could rise sharply, making the U.S. deficit picture look even worse.

Rising rates for government debt would also put upward pressure on private debt, sending borrowing costs up for U.S. businesses and consumers adding another risk to the U.S. economy as it struggles to emerge from the worst recession since the 1930s.

The federal budget deficit hit an all-time high of $1.4 trillion in 2009 and the Obama administration is projecting that this year's deficit will climb even higher to $1.56 trillion.

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