If you’re an investor in U.S. Treasury bonds, should you be worried that China may go nuclear? (No, not that kind of nuclear, the kind in the headline of a recent Reuters article about China’s supposed “nuclear option” to stop buying, if not outright sell, its huge holdings of American government bonds).
According to that report – speculation, really – China may consider retaliating against President Trump’s tough tariff talk by pulling its indirect support of the U.S. government, namely its holdings of about $1.2 trillion of Treasury securities. That makes it the largest foreign holder of that debt. Japan is a close second with $1.1 trillion, while Ireland (Ireland?) is a distant third with $328 billion. Altogether, $6.2 trillion of the U.S. government’s total debt of $20 trillion is held by foreign entities or about 31%. That would put China’s share at about 18% of the total foreign-held amount and less than 6% of the grand total.
In case you were wondering, the Federal Reserve holds about $4.5 trillion of the national debt or about four times what China owns. The Social Security Administration owns about $2.8 trillion.
So, is this something we really need to be worried about, even under the remote possibility that China would actually, in financial terms, cut off its nose to spite its face?
Treasury Secretary Steven Mnuchin, for one, isn’t worried. “I'm not concerned about that,” he told CNBC. “There are lots of buyers around the world for U.S. debt.”
In the Reuters story, Jeffrey Gundlach, chief executive of DoubleLine Capital, also pooh-poohed the idea. “It is more effective as a threat. If they sell, they have no threat,” he said. “It would only escalate the situation and eliminate their leverage.”
Remember that this same issue cropped up earlier this year when Bloomberg reported – or rather speculated – about the same thing happening, which the Chinese government basically dismissed as fake news.
But let’s just say for the sake of argument that China really did want to unload its Treasury bond portfolio in a fit of pique. Would the Treasury market indeed suffer the financial equivalent of a nuclear strike, and what might that look like?
First of all, $1.2 trillion is a big number, but as noted above, it’s a relatively small portion of the total federal debt.
To get the biggest bang for the buck, as it were, and disrupt the U.S. – and global – financial markets, if that were their intention, the Chinese would basically have to unload their portfolio pretty much all at once. That, of course, would be outright insanity, and China would come out the biggest loser of all. If it chose to dump all of that debt at once, prices of Treasuries would likely plunge, forcing the Chinese to take a financial bath. What would be the point of that?
Sales of that kind of volume would no doubt wreak havoc on other global financial markets, including stocks, where we could probably expect equity prices to plunge as well. But what would the effect of that be? It would no doubt push nervous stock investors to seek safety, and where would they might find that? Why, the U.S. Treasury market, of course, where prices would likely rebound, so the net effect would likely be nil.
That scenario reminds me of another silly speculative frenzy back in 2011, when Standard & Poor’s downgraded the U.S. government’s credit rating for the first time ever, to AA+ from AAA. Normally, when a company or a government’s credit rating is cut, the price of its debt goes down, and its borrowing cost goes up, which makes perfect sense.
But when the U.S. government’s credit rating was cut, few smart people blinked. And why should they have? What difference does it make if the American government’s credit rating is cut, when it always has the wherewithal to do what no other entity on earth possesses, namely print more money to pay that debt?
People who were genuinely worried about the government’s credit rating immediately sought safety, which of course drove them straight back into Treasuries. Talk about a virtuous circle.
Of course, if China was determined to rid itself of U.S. government debt and do it without disrupting the markets and lowering bond prices, it could always reduce its new purchases and sell off its existing holdings piecemeal. But that’s easier said than done. Look how hard the Fed is finding it to reduce its own mammoth holdings of Treasury bonds. It will take years to make a serious dent in the total. China’s holdings are a lot smaller, but the same issues apply.
But this, of course, all assumes that China really does want to reduce its holdings, and there is no factual basis to believe that. Where exactly is it going to safely park all the American dollars it brings in every day? As we learned in business school, the only “risk-free” asset is a U.S. government-guaranteed security (assuming it’s held to maturity, of course). That hasn’t changed.
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George Yacik
INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
Let's look again. There's more to it.
Why do they hold it at all? It is only a place to store cash not otherwise required immediately for domestic transactions. Ergo, very short term holding. The fact that they maintain this large $1.2 trillion or so level implies there are reasons other than economic.
Looking beyond the article.
What is the average duration of the China Treasury portfolio? 3-Years? 7-years? 2-years? 90-days? The shorter the duration the greater and immediate the affects of stopping purchases. They will rollover to zero.
How many 30-day, 90-day, 6-month, 1-year, 2, 3, 5, 10, 30-year Treasuries are held?
If much of it is short term, all China has to do is stop buying. In place of debt they will get cash -and very likely the Treasury Department will need to sell additional Treasuries to fund it.
If they were smart, and they are very smart, in this very low interest rate environment they would and should sell the longest term debt held. Take their profits. Likewise, the U.S. selling additional Treasuries to fund it.
The fact that 18% of total foreign debt is held by China suggests to me they are in the cat-bird seat. Thinking that ceasing 6% of total debt demand is a trifle won't meet the acceptance of markets.
I would also think that if China removed itself from the Treasury markets, that other foreign purchasers might do likewise, also begin to reduce their holdings. Even friendly states may object to losses in purchasing power in order to support a U.S. in decline.
Since the U.S. uses its financial weight to punish those who may disappoint the U.S. --for any reason, wouldn't the move to get out from under the U.S. controlled financial systems be given a boost?
Gosh, a number of foreign states that have attempted to move to a currency for its transactions other than the US$ are known to have been invaded by the U.S. with Israel's support.
Could also be that government securities of other states, yes, China, will become a more attractive purchase of foreign states, even to Americans.
Despite the statement in the article, China is not the FED. That staggering $4.5 trillion of FED debt is debt of American banks. Goldman, Morgan, Citi, Wells Fargo. You get the point. But, big BUT here, if things go south the FED will need to prop up the banking system; nationalize the banking system.
Are you prepared for a Bank Holiday? Transfer debt to the U.S. government, ergo, the taxpayer. And sell more Treasuries. Interest rates are going where, exactly?
As many understand the FED made the purchases to stimulate the economy (mostly resulting in higher asset prices) and eliminating it will likely reverse the processes.
Finally, higher U.S. interest rates implies a strengthening US$. In other words, weakening foreign currencies, i.e., the yuan (Renminbi). Why would China not sell or buy Treasuries?
That implies encouraging U.S. imports because they will be cheaper. Ergo, much of what the Trump Administration doesn't want to happen will happen. All this because of China stopping the purchase of U.S. debt??
A cynic might say the reason the Chinese buy our securities is because we ask them to and offer some kind of quid pro quo in return. They'll come to their senses one day and we will be required to get our own house in order. Ouch.