(The opinions expressed here are those of the author, a columnist for Reuters)

ORLANDO, Florida - As the trade war between the United States and China escalates, China is shrinking its holdings of U.S. bonds.

The latest official U.S. capital flows data show that China's stash of U.S. Treasuries and agency bonds in the first quarter of this year fell by just under $40 billion and $10 billion, respectively, on a valuation-adjusted basis.

China is the world's largest holder of foreign exchange reserves with a stash of $3.2 trillion at the last count in April. The currency breakdown is not publicly known, but experts reckon no more than 60% of that is in dollars.

China may have the largest pile of FX reserves in the world but the biggest foreign holder of U.S. Treasuries is Japan, with almost $1.1 trillion. Flows data show that Japan's holdings of U.S. Treasuries rose by $51.4 billion in the first quarter.

This doesn't necessarily indicate outright buying or selling, and China's reduction could well be a result of Beijing choosing not to reinvest in maturing bonds. But the Japan-China comparison is instructive because of where they sit on the global geopolitical spectrum.

While the dollar is unlikely to be displaced as the dominant FX reserve currency any time soon, rising geopolitical tensions and the morphing of globalization into a world of polarized trading blocs could fray its preeminence at the edges.

Indeed, it's probably already happening.

Total global FX reserves at the end of March stood at $12.33 trillion, according to the International Monetary Fund's COFER data, of which the currency composition of $11.45 trillion is reported in confidence to the IMF. The dollar's share was 58.41%, the lowest on record.

A desire on the part of many countries to distance themselves politically from the United States is emerging as one of the key drivers.

In a speech earlier this month, IMF First Deputy Managing Director Gita Gopinath said the increase in gold purchases by central banks over the last two years - the "most notable development" in global FX reserves over that period - points to this.

As Gopinath notes, despite its limited use in transactions, gold is generally viewed as a "politically neutral safe asset" which can be stored on home soil and be insulated from sanctions or seizure.


Measuring FX reserve flows in a world divided into three blocs - a U.S.-leaning bloc, a China-leaning bloc, and a bloc of nonaligned countries - it is evident that the share of gold in the China bloc's total FX reserves has been rising for many years.

But that's not a trend driven solely by China and Russia, as one might expect, although China has clearly reduced its dollar exposure.

As Gopinath highlights, the share of gold in China's FX reserves more than doubled to 4.3% last year from less than 2% in 2015. During the same period, China's valuation-adjusted holdings of U.S. Treasury and agency bonds relative to total FX reserves fell to about 30% from 44%.

The share of gold in FX reserves of countries in the U.S. bloc, meanwhile, has remained broadly stable, evidence that "FX reserve managers tend to increase gold holdings to hedge against economic uncertainty and geopolitical including sanctions risk."

It is the dollar, as the world's dominant currency and symbol of American hard and soft power, that is likely to suffer as geopolitical tensions encourage countries to increase their holdings of gold and other currencies.

But there is nuance within that, according to a recent paper, "Drivers of Dollar Share in Foreign Exchange Reserves," by New York Federal Reserve Bank economists Linda Goldberg and Oliver Hannaoui.

They analyze countries' geopolitical alignment with the United States through the prism of voting with the United States at the United Nations.

In general, the direct correlation between voting records and U.S. dollar share in FX reserves is weak - many nations with a low voting alignment with the United States, or which are subject to U.S.-imposed financial sanctions, are more likely to have a higher dollar share in reserve portfolios, not lower.

More specifically, however, the authors find that the countries with low voting alignment with the United States that are liable to reduce their dollar holdings are those with more than sufficient reserves to meet short-term liquidity and debt obligation requirements.

"A few countries with low geopolitical alignment with the US are responsible for much of the decline in dollar shares," the authors find. "Geopolitical considerations may bind mainly for countries already with large enough reserves to cover their precautionary liquidity needs."

Their research complements a 2022 IMF working paper by Barry Eichengreen, Serkan Arslanalp and Chima Simpson-Bell that showed reserve managers are also increasing their holdings of smaller and non-traditional reserve currencies in search for yield.

The dollar's role in global trade, financing, invoicing, and cross-border transactions is too great for it to be dislodged as the main FX reserve currency anytime soon. But geopolitical tensions may continue to chip away at it.

(The opinions expressed here are those of the author, a columnist for Reuters)

(Reporting by Jamie McGeever; editing by Jonathan Oatis)