China sold U.S. Treasuries in December.

At a record pace. (Well, records for this do only go back to 2000 but still…)

The country sold a net $34.2 billion in Treasuries in the month. That brought China’s holdings of Treasuries to a mere $755.4 billion. That’s down from a peak of $801.5 billion in May 2009.

The decline removed China from its position as the No. 1 holder of U.S. Treasury debt. Japan resumed that position as an increase of 1.5% in December moved its holdings of Treasuries to $768.8 billion.

The net decline of $34.2 billion in China’s Treasury portfolio didn’t exactly show that China is abandoning the U.S. dollar, however.

In the month China sold $38.8 billion in short-term 90-day Treasury bills but purchased $4.6 billion on two to 30 year notes and bonds. That shift into longer-dated U.S. debt certainly doesn’t imply flight from the dollar.

 Instead this seems to be a relatively orderly move that reflects China’s assessment that global financial markets are now safe enough so the country doesn’t need the safety of U.S. Treasury bills quite so much. Especially not when they’re yielding just 0.09%.

The big challenge to the U.S. dollar lies in the months ahead when China removes its renminbi/dollar peg. As long as China keeps the exchange rate pegged at 6.83 renminbi to the dollar in order to support Chinese exports by undervaluing its currency, it has to buy dollars to with renminbi to keep its currency from appreciating against the U.S. dollar. Removing the peg and moving back to the controlled appreciation regime would lessen, but certainly not end, China’s need to buy dollars.

Investment alternatives to Treasuries are likely to include adding more funding to the country’s strategic investment fund, China Investment Corp., increasing investments in overseas sources of raw materials, and providing more funding to Chinese companies for overseas acquisitions. In the current state of the euro and the yen, taking lots of money out of dollars and putting it into those currencies isn’t a terribly attractive alternative.

China’s foreign exchange reserves climbed to $2.4 trillion in December.