With Beijing and Washington continuing to face off over trade, is China likely to sell off its US Treasuries to hurt America? The simple answer is no.
A trade war is essentially a competition about who will be more miserable. If China – America’s largest foreign creditor – sells off its US Treasuries, it will bring down their price and raise their yields. So in theory, China’s holdings of US government debt are a powerful weapon in the trade war.
In reality, the creditor is always in a weaker position than the debtor, and China won’t be able to pressure Washington by threatening to dump US Treasuries.
Foreign investors hold US$6 trillion of outstanding US government debt – which totals around US$20 trillion. China’s holdings of nearly US$1.2 trillion account for about 20 per cent of all US Treasuries in the hands of foreign investors, and 6 per cent of total US government debt.
For China, that means it may have invested some 60 per cent of its dollar-denominated foreign exchange reserves in US Treasuries.
It’s critically important for Beijing to ensure the value of its US dollars because the greenback is its main diplomatic tool for buying influence in Asian, African and Latin American countries with low-interest loans and aid. Those dollar assets also make it possible for China to promote its “Belt and Road Initiative” – a vast trade and infrastructure network spanning Asia, Africa and Europe – via overseas direct investment.
And with few countries in the world in a position to buy such a huge chunk of US bonds, bills and notes from Beijing, it would be nearly impossible for China to find a buyer unless it sold them at a heavy discount.
If it did offload them at lower prices, it would result in a dramatic reduction in the central bank’s assets, weakening Beijing’s financial leverage – and its influence on the world stage.
Meanwhile, other US Treasuries holders such as Japan and Britain won’t be happy if Beijing dumps its US government debt – a move that would hurt China itself and its ties with other creditor countries.
It’s true that China could generate short-term hiccups in the market with changes to its holdings. At the start of the year, as the US Federal Reserve raised interest rates, Chinese officials were reportedly thinking about stopping US Treasuries purchases. This piece of information, which the Chinese authorities later denied, prompted a sharp increase in the US 10-year government bond yield, but hours later it returned to normal.
There was a similar market swing in April, when Russia sold US$47.4 billion of US Treasuries, pushing the US 10-year government bond yield past 3 per cent. It dropped back below 3 per cent the following month.
If China gradually reduces its US Treasuries holdings, it could push up yields, but only temporarily – and it would be unlikely to translate into higher borrowing costs that would inflict pain on US companies and households. US economic fundamentals and the Federal Reserve, not foreign creditors like China, will determine interest rates.
With the US economy in an expansionary period, those who can afford higher costs are trying to borrow more money – and that’s an underlying reason behind rising interest rates.
Meanwhile, US government departments, including social security funds, hold five times more US government bonds than China. Even if Beijing decides to sell, the US has enough ways to manage the impact. For instance, the Federal Reserve can just buy the US Treasuries from China in a balance sheet expansion, and the following cost of dollar depreciation will be shared by all the creditor countries.
As the issuer of the world’s primary reserve currency, the US can exert its privilege.
So if it does offload its holdings, China will definitely harm itself – but it may or may not bring harm to the US. If China really wants to ride out the trade war, selling US government debt won’t help – it has to make changes to its economic model and development strategy.
Zhang Lin is a researcher with the Unirule Institute of Economics in Beijing