Jeff Cox at CNBC says China’s ‘self-destructive nuclear option’ in trade war: Selling US Treasury bonds.
China currently owns $1.13 trillion in Treasurys, a fraction of the total $22 trillion in U.S. debt outstanding but 17.7% of the various securities held by foreign governments, according to data from the Treasury and the Securities Industry and Financial Markets Association. Should the Chinese decide to walk away or reduce their role in the market, that, at least in theory, could create a substantial dislocation for a country such as the U.S. that relies so much on sovereign entities to buy its paper.
“It’s a self-destructive nuclear option,” said Robert Tipp, chief investment strategist and head of global bonds for PGIM Fixed Income. “Maybe it helps them as a bargaining chip, but it’s endangering the value of something they’re deeply involved in.”
“To me, that is the biggest worry. This is really the biggest weapon they have,” said Sung Won Sohn, professor of economics at Loyola Marymount University and president of SS Economics. “They need to do more to counter the United States. So if push comes to shove, that’s what they are going to resort to.”
Treasury yields actually moved lower during Monday’s stock market panic selling despite more chatter of a China bond market retaliation. A tweet from Hu Xijin, editor in chief of the state-run Global Times, noted that “Chinese scholars are discussing the possibility of dumping US Treasuries and how to do it specifically.”
Not Understanding Mathematical Reality
Tipp is on the right side of the argument, but he does not present a clear case why. The rest of the comments are nonsense.
The mathematical reality of the situation is that as long as China runs a trade surplus with the US, China “must” accumulate US assets, over the long haul. It is a mathematical certainty.
China has at times over the past couple of years sold treasuries. But that is not because China wanted to, but rather because China sold treasuries to buy yuan to shore up the yuan and stop capital flight.
For the most part, China does not want the yuan to rise. A cheap yuan helps Chinese exporters.
Buying US Assets
China does not have to buy treasuries. It could buy US equities, gold, or US businesses. But Trump would not let the latter happen.
Buying equities would put China at the mercy of a US stock market decline.
The safest, most liquid choice for China is to accumulate US treasuries with its trade surplus.
That is what China does and will continue to do. There is no realistic option of China dumping US treasuries.
Mike “Mish” Shedlock
The FED printed 4T out of thin air, and can print more. Until foreigners are willing to finance US consumption, China is the loser. The current bunch of loonies has weaponized the dollar, but the Chinese are hardly a white knight for countries that are tired of it.
China could be an independent country without relying on trade if they wanted to. They would need their citizens to consume like one in the US. Theoretically this is possible because they could give their citizens US treasuries they have accumulated that could slowly be given to them and sold over time. China could then seize all foreign owned assets (I believe they already have in many cases as part of agreements to manufacture for US corps). When you have a billion people a lot more is possible. They could cause a huge shortage in goods in America for months and years. We can consume but if there is nothing on the store shelves to consume then what ? As of now China needs us but this doesn’t have to be the case forever.
China has no nuclear option that does not hurt itself more than the US. Imagine if China dumped all its treasuries (to whom at what price) then ran into a capital flight problem. China would be toast.
Once you acknowledge the mathematical certainty that someone must own every dollar, every treasury note, every stock, every bond etc, and combine that with China accumulating dollars via trade surplusses, you realize the picture: China must accumulate US dollar assets.
China can sell and delay purchases as the presidential election heats up next year and tank the markets just before the election. China does not like Trump because they know they cannot trust him and know he feels the same way about them as he does Mexicans.
nipsip,
China cannot dump anything unless it wishes to reverse its trade surplus with the US. The trade is Chinese goods for US Dollars/Treasuries. To reduce their US holdings of dollars and treasuries, China has to stop being a net exporter to the US and become a net importer. Trump would like to see that, China doesnt want that.
So in order to dump US treasuries, China has to start importing US produce. That isnt going to hurt the US one bit.
It’s not just dollars, it’s US dollar-denominated assets. But treasuries are the most liquid and they hold other purposes such as having a cushion to stop capital flight.
“Cant it simply convert the dollars it accumulates from the trade surplus to gold/pounds/francs?”
OK – then who holds the dollars?
What country, set of traders, etc is big enough to hold those dollars.
It is a mathematical certainty that someone has to hold those dollars. Who do you propose?
That is the way to look at it.
If it were 1979 and you were emperor of China, with a GDP of $260 Billion and a population of 969 million living in mud huts, riding bicycles and dressed in Mao suits, would you have bought into a promise to grow the Chinese economy to $13 Trillion in forty years and move 700 million peasants from grinding poverty to comparatively comfortable lifestyles…all in return for accepting several hundred billion dollars of western IOUs annually, mostly in the form of US Treasuries?
Yes, you would; so did Deng, and here we sit.
Indeed, probably the most remarkable economic achievement in all of history. Yet short sighted US critics tend to denigrate the Chinese.
You forgot to mention one important thing – their dependence on American consumption. Taking those IOUs and producing cheaper goods came at the cost of being a subservient economy to the United States and others.
To me the next step function in China and India will be their ability to grow domestically and also rely less on foreign consumption and more on domestic consumption.
In the supply chains of trade, it remains to be seen how the balance of power shifts.
China is falling to twitter just like Trump does to rattle the cages, pay no mind.
China thinks long term, as in decades and is prepared for all scenarios
China’s growth prospects are solid and will soon overtake the US economy in size
China is not politically or economically dependent on the US
China does not depend on the US militarily
China is the largest buyer of US debt and can target the US financial markets
US companies are not leaving China due to the market consumption potential driven by 1+ billion people.
China knows Trump cannot be trusted, knows the US is unprepared for a protracted war and knows Trump is in desperate need for a comprehensive victory
If you want someone to read your comments, you really should break them up into sentences.
You are certainly right, though. China does think in decades while we think in presidential election cycles. And indeed, China knows that Trump can not be trusted, something the US securities market seems yet to learn.
Yes, one of the advantages of a totalitarian state is that you don’t have to worry about pesky matters like elections or term limits. So they will wait out Trump, whether that means 1 year or 5, he will be gone eventually and then they will try to work with his successor.
“China does not have to buy treasuries. It could buy US equities, gold, or US businesses. But Trump would not let the latter happen.”
It can also buy real estate, and they could be fairly invisible in the process, using shell corporations to purchase, say, apartment complexes, and other rental properties. I suspect they are already doing this to some degree.
Chinese are buying lots of U.S. real estate, especially in NYC and along the West Coast, but you can only do so much hiding of ownership of that real estate. Ultimately U.S. businesses and real estate are subject to U.S. jurisdiction, and if China were to do something rash those assets could be seized (just like Iranian U.S. assets were seized).
America’s is China’s ONLY real customer which means they have no choice but to accept our worthless IOU’s because no else wants there cheap crap.Americans takes the checks,handouts they get from gov’t every month and sends it to China via Walmart and Amazon.
Bullshit. China sells a lot to Asia, to the EU and to the rest of the world. The EU buys more than does the US.
So China sells all of its treasuries and gets fiat dollars in return. They’ve traded an interest bearing security for a non-interest bearing security. Why? Of course, behind the scenes, the Fed will be printing dollars and putting them in bank reserve accounts for the banks to buy the treasuries at whatever price the Fed wants them purchased at.
We’re not on a gold standard. This would be a pure loss for China at no cost to the USA. It’ll never happen.
IMO this has gone beyond a trade war and Trump is playing the nationalistic card which has made China feel the same they did in the 18th century. China can easily wait to announce a reduction in purchases or a dump of securities as the US presidential campaign is in full gear in September of 2020. China knows Trump cannot be trusted.
I don’t understand why China can’t demand other currencies or gold in payment. If that payment wasn’t in yuan, then perhaps it wouldn’t strengthen it.
It wouldn’t accomplish anything. They can trade their Yuan for whatever currency they want and buy with that currency.
It would move away from using the dollar or accumulating it as a reserve. It would influence other nations to do the same with their own currencies and eventually bring the dollar down – and force the US away from domination.
China isn’t a single entity like a Monopoly player getting rent on a hotel. It’s millions of businesses and individuals.
Do you think all those businesses want to wait for gold bars to be physically delivered to them? Even if they are, what are they to do with them (where to store them, guard them, use them to buy things they need and pay salaries etc). It would be a nightmare vs just using digital money (essentially that’s all they are getting, credit in a bank account statement someplace) like the rest of the world does.
If they can handle US dollars in payment for their businesses, then it should be little trouble to handle euros or their own yuan or gold instead, as their government could demand. And Russia notes that they often must wait for dollar payments from China to arrive.
Are you saying the Chinese Gov’t would tell all the businesses in China to only accept Yuan or Gold? I doubt the businesses would like that very much.
For example Apple pays Foxconn to assemble/build iPhones. Lets say it’s 1 billion a year Apple pays. Right now that’s in US dollars. They don’t send physical cash, they just send US dollars via bank transfer (ie digital cash). If they demand Yuan, then Apple is still going to send digital cash via bank transfer only this time it will be converted to Yuan (by the banks themselves). The rate is fixed (Yuan doesn’t float) so its essentially the same thing as paying in dollars.
Paying in gold is another matter. That would require physical delivery. 1 billion is 32 tons of gold. That would probably cost Foxconn 10 million to hire a boat and guards to transfer the gold. Seems very unwieldy. This would work for maybe a year or two at most. Then the price of gold would skyrocket as it all ended up in China. At that point Foxconn (and the rest of China) goes out of business. Why? Because they are too expensive to do business with so Apple then gets phones built in Vietnam or someplace else. I doubt China would want all their businesses to go under because no foreign country could afford to do business with them due to cost of gold. This would lead to riots in China when people were out of work.
Your Strawman forgot euros. And they could selectively target a few things such as rare earth metals for gold (or yuan). And target just the US, not all nations. And fix whatever rate seems practical. And their companies would fall in line, like it or not
Being paid in Euros is essentially the same as being paid in Dollars. In one case they would end up with European treasuries, in the other case they would end up with US treasuries. Since the US is considered more stable than the European Block most countries prefer to own US treasuries.
Hard assets as I mentioned are another matter. They can accumulate gold (or silver or any combination of hard assets). The issue is that the more they accumulate the more they drive up the price of that particular asset which then makes their products unaffordable because their prices rise with the hard asset price.
China is accumulating gold. They’ve also accumulated a lot of other hard assets (in terms of mining rights and just plain stockpiling vast quantities of things like copper). They are also buying real estate (check out Vancouver where Chinese students own 20 million dollar homes). This is how they are gradually lessening their US treasury hoard. But 1 trillion is a lot of cash to spend and it’s going to take a while to spend it on hard assets without driving prices through the roof.
And the US doesn’t allow China to buy anything it wants in the US with its excess of dollars. It’s absurd. I don’t see anyone suggesting disaster in gold markets if China keeps buying gold made cheaper by manipulation downward (often notable before market opens)
Mish – maybe this makes me an economic illiterate, but why does China have to continue to hold USD denominated dollars/treasuries? Cant it simply convert the dollars it accumulates from the trade surplus to gold/pounds/francs? Is it an attempt to control the USD/YUAN exchange rates and are they able to do that well?
“Cant it simply convert the dollars it accumulates from the trade surplus to gold/pounds/francs? “
They can. China itself does not strictly have to hold treasuries. It can hold, say, pounds. But then England will have to hold the treasuries it sold pounds for.
Operationally, it is more useful, and less risky, for China to hold bonds denominated in the currency used by those it trades the most with. That way they are less at the mercy of currency fluctuations.
It’s to control the exchange rate. They convert Yuan to USD which increases the supply of Yuan and decreases the supply of USD. USD goes up. Yuan goes down. If they then sell the USD, it drives the USD down. Which they don’t want to happen. They have to get the USD back to the US without exchanging it and they do this by loaning it to us by buying our debt.
Thanks – makes sense. They CANT go nuclear then without hurting themselves
t
There is a simpler explanation. For China to sell, someone else has to buy. The only countries who can buy that kind of volume (hundreds of billions or a trillion plus) are countries who are running massive trade account surpluses. That’s essentially just China and Germany so Germany is the only country they could sell to.
Another option as mentioned is that the US could buy them back by printing cash and giving cash to China. That would devalue the US dollar (due to printing cash) and essentially the US would buy back debt at a discount (if the dollar declined by 10% then the US is buying it’s debt at 90 cents on the dollar) which is great for the US but not great for China.
The final option as Mish mentioned is buying hard assets (gold, real estate, stocks, commodities etc). They are somewhat doing that now in Africa by accumulating resources there via investment in countries and buying mineral rights.
As Kidhorn pointed out above, if the Chinese dump treasuries and go for hard assets, they push up the price of those assets and drive down the price of treasuries and the dollar. 1Trillion of asset sales will have a large impact on the price of anything. When you get that big, simply trying to trade into anything else causes the price of what you are buying and selling to move hugely, and you will lose value in what you hold due to your trades.
A chronic trade surplus is hugely economically inefficient. I would like to know just why China wants to maintain these trade surpluses? It would make far more sense to create policies that will bring their trade into balance.
China has a cumulative $4T+ trade surplus with US since joining the WTO. Where is the other $3T?
China has had trade deficits with other countries. Effectively, much of the USD was converted into those currencies.
No, they also have an export surplus with the EU and many others. There are some countries they have deficits with, but nothing on the same scale. They have not turned those T$3 into other currencies or spent it on trade deficits.
Read this…
Well, they are holding a lot of assets that are not US treasuries, like Greek ports and African railways and farmlands, companies, infrastructure, US and Cdn businesses and real estate, etc etc., as well as sovereign wealth funds and financial assets (stocks, bonds, etc) in other countries.
Most of the world’s petroleum is priced, and only sold in $. China is the largest oil importer in the world at 8.5 mb/d. $186 billion a year of those $ went into buying oil, and will continue to do so. Without oil China does not run, and with $ it has no oil.