photo by SW1994
As the trade war between China and the United States escalates, each side is looking for any advantage. But like a more literal nuclear option, China dumping its massive stash of U.S. Treasurys brings with it the specter of mutually assured destruction.
China is the American government’s second-largest foreign creditor. It was recently the largest, though Japan inched it out as of June. Even so, China still holds $1.1 trillion in U.S. bonds, bills and notes. That represents roughly 18% of the U.S. debt held by foreign countries and about 5% of the country’s debt overall. That is significant by any measure.
This fact has given rise to certain people worrying that China “owns” the United States. I have heard some people express concern that China could abruptly “call in” the debt, wrecking the U.S. economy as a result. Luckily, this is not how bonds work. They aren’t simple IOUs to cash whenever the holder feels like it. Bonds have set maturity dates. What China could do – the so-called “nuclear option” – would be to sell its U.S. Treasurys all at once.
Worry about this possibility spiked in May. A tweet purportedly written by the editor-in-chief of China’s Global Times claimed that “many Chinese scholars are discussing the possibility of dumping US Treasuries.” Given the size of China’s Treasury holdings, flooding the market this way could lead to a dramatic fall in bond prices. This, in turn, would cause U.S. interest rates to skyrocket, pulling the brake on the country’s economic growth.
But there is no real chance China would ever do this.
If China tried to unload all its Treasurys at once, the first sales would be easy. But the more China sold, the more the market would convulse. By the end of its fire sale, China could find itself accepting pennies on the dollar for any remaining Treasurys it held. In the aftermath, China would also likely face a depreciated U.S. dollar. Under those circumstances, American importers might cut back further on Chinese goods because of the new exchange rate, in conjunction with the presumably lingering tariffs. The U.S. is still the destination for nearly one-fifth of China’s exports. So to the extent it reduces demand for Chinese goods, kneecapping the U.S. economy this way would be counterproductive.
China would also face the problem of where to invest its $3.1 trillion in foreign currency reserves. Bonds issued by other strong economies, including Japan and Germany, currently offer zero return at best. Interest rates are fully negative in many cases. It makes for an unattractive set of alternatives, even in light of the ongoing trade war.
Michael Hirson, the China practice head at consultancy Eurasia Group, said that the high-risk strategy of dumping Treasurys en masse simply doesn’t fit with Beijing’s current approach to the trade war. “I think Beijing’s primary motivation right now in the trade war is to be able to withstand pressure from Trump,” Hirson told CNN. Art Hogan, chief market strategist at National Securities Corp, went further and told CBS that a major Treasurys sell-off would be equivalent to Beijing punching itself in the face.
Some analysts have argued that China might be willing to inflict economic damage on itself if something significant were at stake. As an authoritarian regime, Beijing is less constrained by domestic politics than Washington is. In an op-ed for the Los Angeles Times, Tom Campbell – a professor of economics and of law at Chapman University – argued that the status of Taiwan might be an example of such a trigger.
Yet even if, contrary to expectations, China did pursue the nuclear option, it is not a foregone conclusion that it would work as intended. The Defense Department told Congress in 2012 that the Federal Reserve could buy up any Treasurys that China pumps into the market if necessary to avoid negative economic consequences. In addition, market turmoil abroad has sent other foreign buyers flocking to buy U.S. debt in the past. So a spike in interest rates could be temporary, even if China succeeded in creating one in the first place. Especially in a world that lacks for options that are both safe and offer positive returns, it seems likely that other nations would eagerly pick up any slack that China creates in the market for U.S. debt.
China has other options in the trade war beyond tariffs. Beijing has already trimmed its holdings in U.S. Treasurys, if in a less abrupt and destructive way. As of early August, those holdings were about $200 billion less than their peak in 2013. While China buying less U.S. debt will not tank the American economy, it could indicate to investors that China is unwilling to back down in the trade dispute. Other options include continuing to allow the yuan to fall in value, blocking the export of rare earth minerals or organizing boycotts of American goods. Any of these would likely make more sense, and carry less risk for Beijing, than selling off its Treasurys.
The ongoing trade war between the U.S. and China is real and carries real consequences. But there is no indication that China will use the $1.1 trillion it holds as a weapon. The risk of blowback is simply too high.