China’s foreign exchange reserves, the bulk of which are held in US dollars, rose by US$20.7 billion in December. Steven Mnuchin, US Treasury secretary, and his wife Louise Linton pose with a 2017 50 subject uncut sheet of US$1 dollar notes. Photo: Bloomberg
by Neal Kimberley
by Neal Kimberley

China’s brinkmanship over dumping US Treasuries is bound to backfire

Beijing should resist any temptation to link its policy on purchasing US Treasuries to its trade differences with the US

Treasuries, trade and tariffs are a combustible mix at the best of times, but with trade tensions between China and the United States already on the rise, even the suggestion that Beijing could pare, or even stop, its purchases of US government paper should be avoided. It’s simply not in Beijing’s interests to weaponise its holdings of US Treasuries.

In the first place, it’s important to note that it’s not just Washington that has issues about what it perceives as unfair trade practices being employed by China. The European Union (EU) instituted new trade defence rules on December 20.

The accompanying press release from the European Commission stated: “In parallel with the publication of changes to the EU’s anti-dumping legislation, the Commission has today released the first country report envisaged by the new legislation. The Commission selected China for the first report because the bulk of the EU’s anti-dumping activity concerns imports from that country.”

But in the short term, with the possibility that the US may be considering imposing restrictions, including tariffs, on imports of aluminium and steel from China, Sino-US trade tensions are understandably garnering the most attention.

Certainly it’s undeniable that China’s trade surplus with the US has continued to rise. Data released last week by China’s General Administration of Customs showed China’s trade surplus with the US rising 8.6 per cent year-on-year in 2017 to US$275.8 billion, representing 65 per cent of China’s total global trade surplus.

Of China’s US$3.2 trillion in foreign exchange reserves, an estimated US$1.2 trillion is believed to be invested in US Treasuries. Photo: Reuters

It should also be noted that, throughout 2017, China’s foreign reserves rose by US$129.4 billion to US$3.14 trillion. China’s reserves rose by US$20.7 billion in December alone with Switzerland’s Pictet Wealth Management arguing that “China’s trade surplus likely contributed most to the increase in the forex reserves in December, to the tune of roughly US$19 billion.”

Managing US$3.14 trillion of foreign reserves, with some US$1.2 trillion estimated to be invested in US Treasuries, is no easy matter and China’s State Administration of Foreign Exchange (SAFE) has developed strategies to manage that colossal exposure.

“China has always managed its forex reserves investments in accordance with the principle of diversification, to ensure the overall safety of forex assets, to maintain and increase their value,” SAFE said last week. “Investments in US Treasuries [are] managed in a professional way according to market conditions and investment needs.”

Of course it might be tempting to some in Beijing to leverage that US$1.2 trillion of Treasury holdings, or at least to conflate the pace, or even a cessation of, future investments with trade differences, but such a move, aside from surely being perceived by the United States as an unfriendly act, could backfire on China itself.

With the Federal Reserve already having embarked on a succession of US interest rate rises and a calibrated programme of balance sheet reduction, US Treasury yields have already risen. Any perception in markets that China might be less inclined to purchase Treasuries could only weigh on the prices of such paper resulting in yet higher yields.

The value of China’s existing holdings would fall.

A dog sculpture erected outside a shopping centre to celebrate the upcoming 'Year of the Dog' in the Chinese zodiac in Taiyuan. The sculpture, bearing some resemblance to US President Donald Trump, has been actively shared on social media in China. Photo: EPA
Additionally, as Cliff Tan, east Asian head of global markets research at MUFG Hong Kong, noted last week, as Treasury yields rose following President Donald Trump’s election, in anticipation of stimulus, northeast Asian bond yields rose too “and none more so than China”.

“So even in the absence of actual Chinese slowing or selling of Treasuries, Chinese yields would have a tendency to rise in 2018,” he added.

“But an accelerant to that in the form of an overt Chinese threat to sell just strikes us as shooting yourself in the foot,” Tan wrote. An accompanying rise in Chinese yields would create a drag on growth in China itself.

Meanwhile such a development would surely weigh on the broad value of the US dollar at a time when it is already under considerable pressure, having hit a three-year low versus the euro on Friday. The dollar index itself traded at a four-month low.

By definition a weaker greenback makes US manufactured exports cheaper on the world stage and encourages import substitution within the United States as products made overseas become more expensive in US dollar terms. A weaker US dollar, consequent on a market perception of a change in China’s stance towards Treasuries, could ironically end up helping President Trump deliver on his “America First” agenda.

China should resist any temptation to tie its policy on purchasing Treasuries to its trade differences with the US. It’s just not in China’s interests to do so.

This article appeared in the South China Morning Post print edition as: China should not ‘weaponise’ its holdings of US treasuries