The United States is mired in an intensifying trade war with its biggest creditor, raising the specter that China could go nuclear by dumping its $1.12 trillion of US Treasuries.
Investors have grown concerned about how China will retaliate against US tariffs once it runs out of goods to put levies on. China has plenty of levers to pull, including allowing its currency to plunge, blocking the export of rare-earth minerals or even orchestrating boycotts of iPhones and other American goods.
The outbreak in tensions in recent weeks has also led to speculation that China could slash its holdings of US debt. State media in China, the largest holder of US Treasuries, amplified that speculation.
The closely-followed Twitter account of Hu Xijin, the editor-in-chief of China’s Global Times, claimed earlier this month that “many” Chinese academics are discussing the “possibility of dumping US Treasuries.”
Weaponizing US Treasuries
However, Beijing is unlikely to weaponize its vast holdings of American debt because such a dramatic step would likely backfire, perhaps badly. It would deplete China’s own financial resources, dent confidence in the country as a responsible actor and spook global markets. And it’s not even clear that dumping Treasuries would even have the desired impact of hurting the United States.
“China is not going to do that. It’s a pointless exercise,” said Barry Bannister, head of institutional equity strategy at Stifel.
Such a fire sale would be aimed at hurting the value of US Treasuries, thereby causing yields to spike. That would be a big deal because the 10-year Treasury rate serves as the benchmark for other forms of credit. Borrowing costs on everything from auto loans and mortgages to business debt would surge.
“It’s more possible now than at any point in recent history,” said Guy LeBas, chief fixed income strategist at Janney Capital Management.
How it could backfire
However, analysts don’t believe that China would actually dump Treasuries in part because it would be tantamount to shooting itself in the foot. A fire sale would cause its own holdings to lose value.
LeBas called it the “rip your nose off” strategy.
“The last thing they want is to hurt the value of their remaining holdings,” said Michael Hirson, the former chief representative for the US Treasury Department in China.
Hirson, currently the China practice head at the Eurasia Group, said that would reduce the amount of foreign reserves Beijing has at its disposal to defend its currency and maintain financial stability.
China also has limited alternatives for what to do with all its excess cash.
Redeploying the money into Japanese and German debt isn’t ideal. Both nations’ 10-year bonds are yielding negative right now, compared with the shrinking-but-still-positive yield of 2.2% for US Treasuries. The rate on German 10-year bonds plunged to a record low on Friday.
And holding onto the cash would risk allowing China’s own currency to strengthen too much, which tends to be deflationary.
“If China deflates, they’re going to have more bad loan problems at its banks. That’s the last thing they need,” Bannister said.
Another problem with China dumping Treasuries is it risks destabilizing global financial markets at a time when they’re already jittery. Financial turmoil could spill over into the real economy, worsening the ongoing growth slowdown in China’s trading partners.
“If you’re fighting a trade war with the US, you want a stable economic environment for the rest of your exports,” said Hirson.
Would it even work?
It’s not even clear that China would be able to manufacture a panic in the US Treasury market.
China sold $600 billion of US Treasuries between mid-2014 and late 2016 and yet yields went down, according to Stifel’s Bannister.
US debt is viewed as among the safest assets on the planet. There’s ample demand — especially during recent market turmoil — from other foreign buyers, large life insurance companies, pension funds and big banks.
That demand would only increase if China spooked investors by dumping US Treasuries. During scary times, cash tends to flood to US debt.
“There seems to be a ready market in a destabilized world for US Treasuries in a flight-to-safety sense,” said Bannister.
And a modest increase in US Treasury yields could prove to be temporary. Higher yields would likely only attract buyers to come back in, driving rates lower.
“China dumping Treasuries could panic global markets without hurting the US,” said Hirson. “But it would hurt China’s reputation as a source of stability and responsibility.”
Rather than dumping Treasuries, analysts said China will look to retaliate in other ways.
For instance, there is growing speculation that Beijing will order restrictions on the export of rare-earth minerals that are crucial to the technology and defense industries. And on Friday, China’s Commerce Ministry announced plans to compile a blacklist of foreign companies that violate market rules, a likely response to the US export ban on Huawei.
“If the goal is to impair US financial markets,” LeBas said, “selling Treasuries is not the way to do it.”