China tiptoes toward massive retaliation in trade war

Of all the economic threats exchanged recently, the most frightful came from a man most readers might have to google: Cui Tiankai, China’s ambassador to the US. That is saying a lot, considering the tariff arms race being waged between Washington and Beijing.

First, Donald Trump threw US$50 billion Xi Jinping’s way. When China matched that amount, President Donald Trump threatened to toss another $100 billion of levies into the fire. But that is mere noise compared to Cui’s suggestion that Beijing, America’s main banker, might consider scaling back on US Treasuries purchases.

Tariffs will hurt, certainly. The biggest trade powers engaged in a protectionist tit-for-tat will end badly for the entire global economy. But Cui’s not-so-veiled threat is something bigger. To understand why let’s go back 21 years to New York’s Columbia University.

Ultimate trade war weapon

There, in June 1997, then-Japanese Prime Minister Ryutaro Hashimoto was giving a rather dry speech about economic cooperation. That was until the question-and-answer period, when he suggested Tokyo might sell Treasuries holdings if Washington didn’t reduce dollar-yen volatility. “Several times in the past we have been tempted to sell large lots of US Treasuries,” he said.

Japanese officials scrambled to walk-back the comments, denying that Hashimoto was threatening US trade negotiators. But the damage was done. By admitting that Tokyo had considered dumping dollars during tense auto-import talks, Hashimoto validated traders’ worst fears: politics could someday devastate markets.

The dollar, after all, is the lynchpin of the world economy. In the months after Hashimoto’s Columbia University appearance, markets tracked Bank of Japan data daily to see if a giant sell order had been executed. It had not. Hashimoto’s warning shot at US policymakers was eventually forgotten.

The issue flared up anew in August 2011. Beijing was unhappy with then-US President Barack Obama’s perceived closeness to Taiwan. That had policy wags mulling creative ways to get the White House’s attention, including using Beijing’s vast dollar holdings as leverage.

“Now is the time,” the state-run People’s Daily argued in an editorial on the topic, “for China to use its financial weapon to teach the US a lesson.”

Tough or bluff ?

It didn’t happen, of course. A dollar fire sale could slam global growth in ways that would boomerang back to China. Aside from massive paper losses on Beijing’s $1.2 trillion of Treasury debt holdings, the resulting surge in US yields could savage the American consumer on which Chinese growth relies. That might imperil the trajectory of China’s debt-and-credit-driven growth.

It is also worth noting that China and Japan are, to some extent, trapped. Any transparent effort to shift from dollars to, say, gold, would panic markets. As far back as 2009, then-Premier Wen Jiabao seemed to see the writing on the proverbial wall. He worried that Washington’s massive stimulus efforts might erode the value of Beijing’s Treasuries.

“We have made a huge amount of loans to the United States,” Wen said. “Of course, we are concerned about the safety of our assets. To be honest, I am a little bit worried.” He called on the US “to honor its words, stay a credible nation and ensure the safety of Chinese assets.”

Fast-forward eight years to December 2017. Wen’s successors couldn’t have been happy to see Trump’s Republican Party passing a $1.5 trillion tax cut the US economy didn’t need. Trump’s party is taking for granted that Beijing and Tokyo will dutifully gobble up more dollar debt, financing Washington’s fiscal boost.

Beijing’s concerns are plenty valid. In 2011, two years after Wen’s plea, Standard & Poor’s downgraded Washington, the first credit-rating company to yank away its AAA status. America’s balance sheet has been larded up exponentially since then. And now Trump’s trade war risks repelling Washington’s Asian bankers.

As Cui, China’s man in Washington, suggests, Xi’s team is now “looking at all options.” While Trump doing his worst with tariffs is worrying, the idea of Xi pulling the plug on the dollar is positively terrifying.

Trump must remember that even though he runs the biggest economy, Xi holds the deed.