I've wondered why China invested so much money in America for a long time now. If you're the Chinese government and you've got a lot of investment capital, it seems like you'd do well to invest in China. You aren't afflicted by the kinds of problems that face foreign investors in emerging markets like "What if the government makes a policy change that screws me?" since you are the government. You're better positioned than any foreign investor to capture positive externalities that spill over from your investment, since they mostly spill into your country. Plus, China looks like a place that's ripe for investment that allows it to become more productive.
My thought is that you'd want something countercyclical that wouldn't lose tons of value if the global economy tanked, and US Treasury bonds can work that way, so that's a benefit. I don't know how well that works when you've made such a big investment that it's tough to get out, though. Matt's view is that this is a result of IMF failures from the 1990s. There's probably a bunch of things going on here, and I'd be curious to hear more thoughts on this.
China does invest in China, in many ways more than our government does. However, historically they have needed hard currency to buy raw materials. Also, they have been propping up our economy to support their factories in Shenzen and the other export zones.
They have largely stopped "investing" in the US. Don't confuse purchase of US Treasury securities in order to keep the RMB¥ low as being an "investment" in the US Treasury securities - its an investment in cheap currency to win market share. Its just that selling the Treasury securities again would spoil the effect, so if you are going to peg at a discount, you end up accumulating securities denominated in the other currency as a side effect.
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