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Every few years, Chinese officials send a warning shot Washington’s way, hinting that they could dump mountains of US Treasury securities to show America who is boss.
This “nuclear option” has been spoken of in hushed tones for years, spooking financiers fearing chaotic and disastrous collateral fallout since at least 2009. That year, then-Chinese Premier Wen Jiabao made a public plea to US Treasury Department officials.
“We have made a huge amount of loans to the United States,” Wen said then. “Of course, we are concerned about the safety of our assets. To be honest, I am a little bit worried.” He urged the US “to honor its words, stay a credible nation and ensure the safety of Chinese assets.”
Chinese state-run media have since periodically hinted that Beijing might go nuclear, in the financial sense. In 2011, the People’s Daily argued that Beijing should “use its ‘financial weapon’ to teach the US a lesson.” At that time, the flashpoint was Washington cozying up to Taiwan.
In May 2019, the Global Times reminded the White House that Beijing could pull the rug out from under America’s borrowing programs. Hu Xijin, editor-in-chief of the pro-Beijing publication, wrote that “Chinese scholars are discussing the possibility of dumping US Treasuries and how to do it specifically.”
Now, the nuclear genie is out of the bottle again. Last week, Global Times unleashed yet another shot across Washington’s bow, quoting Xi Junyang, a professor at the Shanghai University of Finance and Economics.
“China will gradually decrease its holdings of US debt to about US$800 billion,” from today’s US$1.1 trillion, he said. He added, “But of course, China might sell all of its US bonds in an extreme case, like a military conflict.”
Time to head for the financial fallout shelters? Not necessarily. It’s never clear how close these provocative editorials correspond to the debates underway in President Xi Jinping’s office or among his inner circle.
It’s also true, though, that in the winks, nods and secret handshakes that surround Beijing’s PR machine, it’s often academics in state-backed media who float trial balloons for Communist Party bigwigs.
But this latest floater is likely to be more of a lead balloon than a hydrogen one. It’s entirely possible that Beijing could throw caution to the wind and ruin US President Donald Trump’s pre-November 3 election stock rally.
While it’s true China would book massive losses by selling down its Treasury debt holdings, some wonder if Xi might be willing to take a $500 billion or more haircut to potentially upend Trump.
In such a scenario, government bond sales would likely start quietly and then accelerate. Markets would eventually get wind that Washington’s No. 2 banker after Japan is selling assertively. And one of history’s greatest rushes for the exits would be up and running.
Yet the ways in which the fallout would reverberate back China’s way make the costs of this self-inflicted option likely far too great.
Economist Kim Rupert sums up the risks as such: “China will continue to use this as a threat, perhaps, but in reality I think it hurts them more than it might hurt [the US].”
Besides, notes Patrick Chovanec of Silvercrest Asset Management, the likely plunge in the dollar after Beijing sold down its Treasuries would make it harder for Chinese policymakers to offset US tariffs via a competitive exchange rate.
The end result, he notes, would be “the exact opposite of what China wants.”
Another key reason Xi won’t likely go this route is the fallout to Brand China – already heavily impacted by the global pandemic, which originated in the Chinese city of Wuhan – would suffer.
Its designs on making the yuan a potential replacement for the dollar in global trade are proceeding steadily and convincingly. A nihilistic step to dump Treasuries – imperiling global markets everywhere – would set back China’s progress in filling the Trumpian void.
It would also be seen as a kind of declaration of war in certain circles, a sign that China is willing to throw economies everywhere under the bus for narrow national gain.
That, of course, is Trump’s brand. Chinese officials would be loath to be blamed for the next international crisis, as Wall Street was blamed for the global financial crisis in 2008.
However, there is a less catastrophic way for Xi to use China’s vast US Treasury holdings as leverage over Trump.
As America’s Covid-19-wracked economy staggers toward the November election, Trump and his fellow Republicans are turning to a tried-and-true strategy: tax cuts.
In recent decades, the Republican Party’s immediate pivot after any calamity – 9/11, Hurricane Katrina, the “Lehman shock,” Covid-19 – is to lower tax burdens on businesses and households to save the day.
As the US job rebound slows, Trump’s party is talking about capital-gains tax cuts, payroll tax cuts, middle-class tax cuts. You name it, here are the tax-cutting scissors.
What they’re not admitting aloud is China’s role in financing the next round of budget-busting fiscal stimulus. It’s merely assumed that America’s top bankers, virtually all of them in Asia, will happily oblige by continuing to buy US debt.
Yet Xi Junyang’s September 4 Global Times quote suggests China can inflict grave damage on Trump’s America by merely throttling back its purchases. Xi’s suggestion seems a far more sensible strategy than an actual fire-sale of US Treasury securities.
Such a move would send strong shockwaves through markets. Other monetary authorities might race for the exits, fearing billions of dollars of lost state funds.
Even if Japan, America’s top banker with $1.26 trillion worth of US Treasuries, took one for the Trumpian team and didn’t sell, would the UK, with $446 billion at stake, help Washington? Or Saudi Arabia with $125 billion?
Who knows? But threats and even idle thoughts to that effect can shake markets.
That’s what happened when Ryutaro Hashimoto, Japan’s prime minister in 1997, let slip during an otherwise dry speech at New York’s Columbia University about the history of US-Japan trade that Tokyo had considered using the nuclear financial option during tense auto negotiations in the early 1990s.
“Several times in the past,” he said, “we have been tempted to sell large lots of US Treasuries.”
Now China’s finger is on the same button.
In February 2018, Dan Coats, then the US national intelligence director, said the fact that so much of America’s “unsustainable” debt is held by adversaries is a “dire threat to our economic and national security.”
Again, though, this “self-destructive nuclear option,” as strategist Robert Tipp of PGIM Fixed Income calls it, is a mere “bargaining chip.”
The fallout that would boomerang back China’s way is its own deterrence against such a drastic act. For one, it would squander too much of the economic soft power Xi’s government has amassed as Trump infuriates US ally after US ally.
Instead, Beijing could put its foot down and make clear it will not be helping Trump and his Republican cronies finance its Covid-19 inspired fiscal excesses. In the same breath, it could make clear that China will endeavor to draw its exposure to US Treasurys down to, say, $800 billion, as per academic Xi Junyang’s number.
China will always need a certain supply of the reserve currency, both to facilitate trade and maintain diversification amongst its nearly $3.2 trillion of foreign exchange reserves.
But Beijing is currently in a long-term play to make the yuan the medium of choice in global trade. Would Beijing want to endanger this huge and important project by causing international market chaos?
Given China’s scale and its role as a top trading nation, phasing the dollar out as a middleman currency would reduce costs and increase efficiency.
Meanwhile, Washington its digging its own grave in terms of global respect.
Call that Washington’s own nuclear option. It’s one, of course, that could crater the global financial system. Who, in future, would entrust billions of dollars of national savings to a government willing to effectively default as a revenge tactic?
Markets have taken notice and boosted demand for a hedge against the dollar.
There was a time when “yuan internationalization was a ‘good-to-have,’” says economist Shuang Ding of Standard. “It’s now becoming a ‘must-have.’”
It’s up to China to remind Trump of an inconvenient reality. Washington may have built a shining and productive economy on a hill, but China is the pivotal holder of the mortgage.
That accords Beijing financial firepower, more than Trump likes to admit. But smart brokers wield power with prudence and it’s not clear yet the nuclear financial option is actually on the table.