Zikun Xu

Date Approved

2014

Date Posted

5-19-2014

Degree Type

Open Access Senior Honors Thesis

Department or School

Accounting and Finance

First Advisor

Robert C. Hanson

Second Advisor

Asrat Tessema

Abstract

In the summer of 2010, the U.S. debt ceiling dispute attracted the attention of the world, and financial markets were shocked when Standard & Poor's finally cut the United States AAA rating. But with the increase of the debt ceiling as well as the European sovereign debt crisis intensified, the U.S. national debt problem was temporarily covered up. It must be noted, however, that the U.S. national debt has ballooned to the highest level since World War II, the ratio of national debt to GDP has reached to nearly 100%, coupled with the long-term U.S. fiscal deficit and the continuing economic stimulus policies. Its debt levels will continue to expand, and we must pay our sustained attention to the U.S. debt problem. Today, global economy is highly integrated; other countries will inevitably be affected with a nation's sovereign debt crisis outbreak. And due to the special status of the United States in the global economy, the impact on global financial markets is immeasurable if U.S. Treasury bonds default. Therefore, the sustainability of U.S. Treasuries not only affects the credibility of the United States and its economic development, but also affects the stability and development of the global economy. China, as the largest overseas holder of U.S. Treasuries, has invested most of its foreign exchange reserves in U.S. Treasuries. The sustainability of U.S. Treasuries not only affects the security of China's foreign exchange reserve assets, but also affects China's financial and economic fields. Consequently, it is of great theoretical and practical significance to research the sustainability of U.S. Treasuries, its impact on China's economy and the countermeasures to be taken by the U.S.

The sustainability of U.S. Treasuries and the measures that may be taken will certainly have an impact on the Chinese economy since China is the largest holder of U.S. debt. This paper analyzes the influence from six areas: foreign exchange reserve, exchange rate, capital flow, inflation, monetary policy, and foreign trade. The analysis shows that the measures will lead to a decline in the value and the purchasing power of China's foreign currency reserve assets, affect the autonomy of China's exchange rate fluctuations, promote the appreciation of the RMB, increase the pressure of inflation, influence the Independence of China's monetary policy, affect China's trade growth, disrupt the normal process of China's economy, and restrict China's policy options. Therefore, some measures should be undertaken to deal with the risks. China should transform the economic development pattern and restructure the economic structure. This economic transformation could promote China's foreign exchange reserves investment, diversify foreign exchange reserves portfolio, and increase the limit of foreign exchange reserves' holding by individual and enterprise investors. We also can improve and perfect the RMB exchange rate formation mechanism, promote the reform of the international monetary system and speed up the internationalization of the RMB. And U.S. treasuries that China holds can be kindly used as a counter to protect Chinese interests and enhance Chinese international influence.

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