The math works against China in its trade war with President Trump.
Since China’s imports to the United States are about three times the amount of US exports to China, Trump has a much bigger basket of stuff he can tax with tariffs, his own favorite weapon. He knows this and has threatened tariffs on almost all of the $524 billion in annual Chinese imports to America. The United States only sends about $188 billion worth of stuff to China each year. So in terms of tariffs, China is more vulnerable simply because it’s such a huge exporter.
But China has other levers to pull, and one of them is an abrupt selloff of the roughly $1.5 trillion in U.S. government securities the country holds. “Aggressive dumping of U.S. Treasuries back into the market would pose double trouble for Washington,” a commentator wrote recently in the South China Morning Post. “It should give more leverage to Beijing’s tacit devaluation tactics and cause wider scattergun carnage to the US economy at the same time.”
A Chinese selloff of U.S. debt is an intriguing scenario most trade experts think is unlikely. It would, in fact, cause problems with the U.S. economy — but it might hurt China even more. Trump’s trade war, however, may just be getting started, and a destabilizing move by China could become more likely if Trump continues to slap tariffs on Chinese imports, which is beginning to hurt China’s economy.
China holds around $1.2 trillion worth of Treasury securities, along with another $200 billion or so in debt from U.S. government agencies such as Fannie Mae. There’s another $100 billion worth of Treasuries China reportedly holds through custodians in other countries. So it holds around $1.5 trillion in U.S. government debt, in total. China is the world’s biggest foreign holder of U.S. Treasuries, which worries some analysts. But its holdings only total about 6% of all Treasury debt. All foreign entities combined hold only about 30% of U.S. debt. Americans, in various forms, own the other 70%.
Still, an unexpected selloff of China’s Treasury holdings would undoubtedly rattle financial markets. “If China sells U.S. Treasuries as part of its response to the escalating trade war with the U.S., it would be highly disruptive, pushing up interest rates and undermining global financial markets,” Mark Zandi of Moody’s Analytics tells Yahoo Finance. “Investors would view the move as a significant escalation in the trade war, signaling that it will continue on for much longer and do much more economic damage.”
If it were to happen, economists think rates would rise by around 30 basis points, or three-tenths of a percentage point, which would be an abrupt change if it occurred in a short period of time. Rates would rise because a new supply of debt on the market would lower the value of bonds, forcing borrowers like the U.S. government to pay more. Rates on mortgages, car loans and most other consumer and commercial debt would rise in tandem. Investors might dump stocks for bonds, where they’d suddenly get a higher return.
This would happen as the Treasury is already flooding the market with new debt to finance the Trump tax cuts, which is why some analysts think the United States is unusually vulnerable to a Treasury rout. “On the surface, it looks like the U.S. is extraordinarily vulnerable,” Brad Setser of the Council on Foreign Relations, a former top official at the Treasury Dept. and International Monetary Fund, wrote recently.
But other crucial developments would follow, mitigating the damage to the United States and compounding it for China. The Federal Reserve, eager to prevent a crisis, would probably change monetary policy and began weakening instead of tightening, as it is doing now by gradually raising interest rates. This would reassure markets, and if it didn’t, the Fed could crank it up a notch or two by buying Treasuries and taking other extraordinary measures. “The Fed is the one actor in the world that can buy more than China can ever sell,” Setser wrote.
China itself would be negatively affected by rising interest rates, just as other nations would be. It would have to find new liquid investments to replace its massive Treasury holdings, which could further destabilize a turbulent market. And the value of China’s currency, the yuan, would most likely rise as the value of the dollar fell. That would impair and possibly crush China’s export economy, while it would make American exports more competitive, a relative boost to U.S. producers.
China might also become something of a pariah state, seen as undermining the global financial system, rather than participating in it. That could drive away foreign investors who have become an integral part of the Chinese economy. That’s why many analysts who have studied the scenario think a Treasury selloff could backfire and hurt China more than anybody else.
“It seems unlikely the Chinese would go down this path,” Zandi says. “Yuan devaluation is a much more effective response to higher tariffs.” China has, in fact, been doing that, with the yuan losing about 7% of its value against the dollar since mid-June. That offsets some of the impact of the new Trump tariffs on Chinese imports to the United States. China devalues the yuan by buying dollars and, typically, US Treasuries. And it can’t buy if it’s selling.
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Rick Newman is the author of four books, including “Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman