What Motivates China to Invest So Heavily in U.S. Treasury Securities?

Abstract

This paper attempts to shed light on the question: What motivates China to invest so heavily in U.S. Treasury securities, despite the fact that U.S. Treasuries provide real rates of return that are either close to zero or negative? Such an investment strategy can be perceived as economically irrational. A linkage can be presumed between China’s investment practices and the tactical decision to moderate the United States’ influence on economic, political, and military issues. We hypothesize, however, that China does not have a better investment option because holding an ever-increasing amount of U.S. dollar-based liquid assets gives China the ability to manage the value of the yuan in order to force its desired trade surpluses. In other words, China’s main mechanism to secure a positive trade balance and increase its foreign direct investment is by maintaining an undervalued currency, which requires an ever-increasing foreign-exchange reserve. From what we know, our study is the most comprehensive empirical examination of motivations for China’s heavy purchases of U.S. Treasury securities by analyzing nearly 25 years that begins in 1987 and covers the period over which China dramatically increased its holdings of these instruments.