Over the weekend, on the sidelines of the IMF annual meetings in Bali, Indonesia, Steve Mnuchin expressed a lot of confidence in the world’s appetite for U.S. debt at a time when the deficit is ballooning thanks to the Trump administration’s plunge into late-cycle fiscal stimulus.
“We have plenty of buyers for Treasurys”, Steve said, adding that when it comes to rumors that China might just decide to stop buying (or worse, start liquidating) in light of Trump’s aggressive trade posturing, the issue has “never come up whatsoever” in his discussions with Chinese officials. Obviously, that’s a lie. Even if it hasn’t come up in the form of a threat from Beijing, it’s at least come up in the context of market rumors.
Mnuchin went on to say that China is “free to do what they want to do” but added that he “hopes” China still “thinks it’s good to hold U.S. assets”.
Well, on Tuesday, we learned that China’s holdings of U.S. Treasurys slipped for a third straight month in August to $1.165 trillion, down from $1.171 trillion the previous month.
It’s worth noting that starting on August 3, China embarked on what would turn into a four-pronged effort to arrest the slide in the yuan. Right up through the end of July, the PBoC appeared to countenance currency depreciation in the interest of shielding exports from the effects of the tariffs.
This comes at a time when talk of de-dollarization again permeates the macro narrative. The de-dollarization theme has waxed and waned over the years, garnering attention when the headlines demand it (e.g., when the AIIB was in the news every other day) and fading from the discussion when not.
But the Trump administration has changed the calculus and increased the perceived urgency of diversifying away from the dollar.
The more aggressive the U.S. is when it comes to effectively using the greenback as a tool of economic warfare and deploying that weapon indiscriminately against allies and enemies alike, it’s possible that the world will begin to see more utility in de-dollarization. As JPMorgan’s Marko Kolanovic put it late last month, “with the current US administration policies of unilateralism, trade wars, and sanctions increasingly affecting both friends and foes, the question arises whether the rest of the world should diversify away from the risks of the USD and USD-centric finance.”
The drawdown in emerging market equities and the acute pain across EM FX this year amid Fed hikes is yet another stark reminder of how excessive dollar dependence can go awry during U.S. tightening cycles.
A week ago, BofAML observed that in Q2, the share of RMB holdings in foreign exchange reserves surged by 0.44%, representing the biggest QoQ jump in history. And that wasn’t even the most shocking part.
“Although astonishing in itself, this percentage increase may still be significantly underestimating the RMB buying in Q2”, the bank wrote, adding that if you account for CNH depreciation, “the increase in the RMB share would imply that CBs bought the equivalent of $55bn in RMB assets over Q2, compared to less than $17bn in Q1.”
In a note dated Monday, Goldman takes up the same discussion, writing that “in Q2 of this year the Dollar’s share of reserves took a notable step down”. According to Goldman’s calculations, “the proportion of reserves held in Dollars fell by 1.0-1.3pp [and] the drop was mirrored primarily by higher allocations to the Euro and Yuan.”
Goldman attributes this in part to sanctions risk, before zeroing in on Russia’s widely reported selling of U.S. debt. After reiterating that Russians liquidated $85 billion in Treasurys during April and May (the largest two-month decline in history), the bank goes on to say that “the Fed’s custody holdings of Treasury securities for foreign official investors fell sharply after sanctions were announced, and the TIC data’s (imperfect) measure of official sector Treasury holdings dropped by $63bn over April and May together”.
Clearly, the implication is that Russia was selling in response to the sanctions and Goldman goes on to say that the IMF Q2 reserve data referenced above suggests that Moscow did not in fact simply shift these holdings to non-US custodians. Rather, Russia looks to have diversified into euros and yuan.
Getting back to the August data, at the aggregate level, foreign holdings of U.S. Treasurys rose $35.4 billion to $6.287 trillion. So maybe Steve is right that there’s plenty of demand.
Still, it does indeed appear that slowly but surely, Trump’s “America first” policies are having the effect of accelerating the de-dollarization push.
There’s more than a little irony and poetic justice in that.