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On October 17, a report by the U.S. Treasury highlighted a noteworthy shift in international capital flows. After four consecutive months of reducing their holdings, Japan reversed its course and began increasing its investment in U.S. Treasury bonds again in August. This trend marked a significant turnaround not just for Japan but also for other nations like the United Kingdom, France, and even the Cayman Islands, all of whom chose to strengthen their positions in U.S. debt amid a backdrop of declining interest rates from the Federal Reserve.

In stark contrast, China and Canada adopted a more cautious approach, opting to reduce their stakes. China, in particular, reported a consecutive reduction in its treasury holdings, cutting back by $1.9 billion, which translates to approximately 134 billion RMB. This decline brings China close to a historically low level of U.S. Treasury holdings, not seen since 2009. Meanwhile, it's critical to note that gold prices have been on a steady rise. Central banks globally are turning into significant buyers of gold, and China is leading this charge.

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Why is China the only country reducing its U.S. Treasury holdings?

The United States has long enjoyed the status of the world’s financial hegemon, thanks to the dominance of the dollar. However, the country is currently grappling with a severe debt crisis, having amassed a staggering $35.2 trillion in national debt—a figure that continues to rise rapidly. What’s more alarming is that U.S. debt has increasingly become embroiled in political issues, raising concerns about global financial stability.

This disconcerting situation has prompted the Federal Reserve to consider monetary policy adjustments, notably lowering interest rates. It’s important to understand that bond yields and prices move inversely in the secondary market—when yields rise, prices fall and vice versa. One critical factor influencing the yield on U.S. Treasuries is the Fed's interest rate adjustments. An increase in rates typically leads to higher yields and, correspondingly, lower prices; conversely, a decrease in rates results in lower yields and increased prices.

 

In September, the Federal Reserve’s decision to cut rates by 50 basis points led to a decline in bond yields, consequently boosting the prices of U.S. Treasuries. This environment of rising bond prices and declining yields has encouraged several countries to reconsider their investment strategies in U.S. debt.

The renewed interest in U.S. Treasuries may help ease America’s debt crisis, creating a favorable situation for global financial markets. Yet, the question remains: why is China consistently divesting from U.S. Treasuries?

Like other nations, China views U.S. Treasuries primarily as an investment tool, expecting reasonable returns. The prior years of continuous rate hikes by the Federal Reserve played a significant role in China's decision to scale back its Treasury holdings. But beyond mere investments, the geopolitical landscape complicates matters. The dollar reserves and U.S. bond holdings of other nations have increasingly become potential leverage points for the U.S. to impose restrictions or exert pressure.

A stark example of this occurred when the U.S. froze Russian assets and expelled the country from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system, cutting Russia off from global financial markets. In this strained context, China’s reduction of U.S. Treasury holdings is a strategic move to mitigate risks associated with dollar reserves.

 

Furthermore, the stability of the yuan’s exchange rate is paramount for the health of China's financial markets and economic development. In earlier scenarios marked by the dollar's aggressive rate hikes, China found it necessary to use dollars to purchase more yuan to stabilize risks stemming from potential depreciation. However, with the Fed implementing a more accommodative monetary policy through rate cuts, there may be a logical pivot for China to start increasing its Treasury holdings for improved yields.

That said, this potential shift is speculative. Countries like China and Russia are actively working on establishing a BRICS payment system. If successfully implemented, a trend towards de-dollarization may very well be on the horizon.

 

Is gold poised to replace U.S. Treasuries as a safe haven?

Recent discussions have centered on the surging price of gold, which has recently eclipsed $2,700 per ounce. This surge is partly attributable to the Federal Reserve's monetary policies. Following the Fed's announcement to cut rates on September 19, there was widespread anticipation regarding the favorable implications of these measures.

However, as the U.S. Department of Labor released strong non-farm employment data on October 4, indicating a robust job market and declining unemployment, the pace of rate cuts by the Fed appeared to stabilize. This new sense of uncertainty prompted many investors to view gold as a more reliable safe haven asset.

 

Indeed, every instance of Fed rate cuts in the past has been accompanied by rising gold prices. This pattern was evident during the 2008 financial crisis and again in 2019. Moreover, the instability in geopolitical climates has further driven financial institutions and individual investors alike to procure gold as a hedge against uncertainty.

 

As gold gains greater prominence in international reserves, it is reshaping the composition of global foreign exchange reserves. There is a growing belief that gold could rival U.S. Treasury bonds as the safest available investment vehicle. However, this trend is not set in stone; should inflation ease or actual interest rates spike, a retreat in gold prices remains a possibility.

China, now one of the primary holders of physical gold in the global market, recognizes that the future of national power is tied to gold reserves. In the event of a dollar collapse, the nations with the highest gold holdings will likely dominate the new international financial framework.