People's Bank of China (PBC) sold US Treasuries for more than $90 billion in August and it's not the first dumping this year. According to Bloomberg, China's international reserves dropped by $315 billion during the last 12 months.

 

Why is China selling US bonds? This seems to be a forced step, like the purchase of the bonds before. During the last 20 years, China's economy has grown significantly and has attracted new investments into the country. In order to compensate for both inflow of foreign investments and balance of payment surplus, caused by the increase of purchases of Chinese goods and to prevent the snowballing growth of yuan, the People's Bank of China was forced to constantly do interventions by buying the US currency. These newly bought dollars had to be invested. The US Treasuries turned to be the only liquid and reliable market that could meet the Chinese appetite. China has become the most important and significant buyer of US bonds like this.

Today we can see a completely different situation. The decline in Chinese exports and the capital outflow from the country are rising so fast that company profits can't compensate for the cash outflow. The Central Bank is forced to gamble again — "pull" dollars by selling US Treasuries and buying yuans. The alternative way is greenback emission which the Chinese regulator does not want to resort, remembering unlucky example of  Japan and Eurozone.

 

What will happen if China keeps on dumping such a massive share of its dollar reserves or, even worse, increases the sales? Theoretically, the appearance of such a large seller could crash any market and cause very unpleasant consequences for the US. Plunging bond prices will rocket all yielding curves; and the country will neither be able to service the current debt, nor to increase the credit line by means of issuing new bonds.

 

But the scenario seems quite unlikely to me, and here's why. Investors are always trying to transfer their funds into safe investment shelters in the times of market turbulence. We already had one last August, witnessing huge drop of all markets and commodity assets. Up to now no one came up with nothing more reliable than government bonds. And the leader here is, of course, US bonds. So we can always find the buyers. With a shortage of free market investors, banks will always remain the largest holders of the government debt. During the crisis, the US Government put a lot of effort to save the banking system from a collapse. Perhaps, it's time for the banks to pay debts and save the Government.