Background of the Study

Given its relatively low savings rate, the U.S. economy depends heavily on Ioreign capital
inIlows Irom countries with high savings rates to help promote growth and to Iund the Iederal budget
deIicit. Historically, buying U.S. government bonds has been a saIe investment, since the risks oI the
U.S. deIaulting on the loan have been very low, while the chances oI the dollar increasing in value have
been high.
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Among the Ioreign buyers oI US securities, China stands one oI the largest. The United States is
a major destination oI China`s overseas investment. As oI 2008, China has surpassed Japan as the largest
holder oI US Securities. Why does China buy Treasury securities? China`s central bank is a major
purchaser oI U.S. Iinancial securities because oI its exchange rate policy. To mitigate the yuan`s
appreciation against the dollar, the central bank needs to purchase dollars (Morrison and Labonte, 2008).
Rather than hold dollars, which earn no interest, the Chinese central government has converted some level
oI its Ioreign exchange holdings into Iinancial securities. Since Ioreign exchange holdings Iacilitate trade
and prevent speculation against their currency, the central bank also holds securities Irom other Ioreign
countries. China's purchase oI U.S. bonds makes the dollar stronger, particularly against the Chinese
yuan, which has been kept artiIicially weak to boost Chinese exports.
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China`s investment in U.S. government debt has more than tripled, Irom $71 billion in 2000 to
$242 billion in 2005 (ReIer to Table 1). In the recent report oI the US Treasury Board, its investment rose
to $1173.5billion b as oI July 2011.
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But its total holdings even rolled up to $1.16trillion by the end oI
December 2011, based on the annual revision oI Iigures conducted by the U.S. Treasury Department.
Apparently, China has become the biggest holder oI U.S. Treasury securities dated 2011.

Guide Questions:
1. How signiIicant is China`s holdings oI US securities to the sustenance oI the US economy?
2. Is there a possibility that this economic hold will translate to political control?
3. How likely is the possibility oI a US deIault on its debt?
4. There is a current move to diversiIy Irom the dollar and promote the yuan as a reserve
currency. What is your projection on this? Is this a viable move Ior China or will it remain
committed to the dollar?
5. China is currently decreasing its purchase oI US securities, will it resort to dumping or
abandoning US securities altogether?
6. China is urging American policymakers to protect the interest oI creditor states, how should
they respond to this?
7. II the US will revert to protectionist policies amidst the Iact that it owes a huge amount oI
debt to China, how will this aIIect US-China relations altogether?