China’s Threat to Dump Treasurys Has No Bite

A man walks past the National Debt Clock on 43rd Street in midtown Manhattan, New York City on Feb. 15, 2019. Timothy A. Clary/AFP/Getty Images

News Analysis

A May 13 tweet by the editor of a state-run Chinese newspaper set off speculation that China may stop buying U.S. debt and begin selling Treasurys.

Hu Xijin, chief editor of the hawkish newspaper Global Times, said in a tweet on May 13 that “Chinese scholars are discussing the possibility of dumping U.S. Treasuries and how to do it specifically.”

China’s possibility of dumping its massive holdings of U.S. debt has long been considered a “nuclear option” to force the United States to capitulate in the ongoing trade war. Some believe that a massive sale could trigger a sudden increase in U.S. interest rates and hurt the U.S. economy.

Despite the threat, this has an almost zero chance of happening. It would have little impact on the U.S. economy and would only be counterproductive for China.

Partially driving the ongoing angst is that China’s stockpile of U.S. Treasurys has actually been decreasing. China’s holdings, as of the end of March, fell by $10 billion, its first drop since November 2018, to a two-year low of $1.12 trillion, according to data released by the U.S. Treasury Department on May 15.

While $10 billion sounds high, it’s actually quite small—it’s a less than 1 percent change from the prior month.

Large Demand for US Paper

In theory, China can increase the U.S. government’s borrowing costs by dumping Treasurys. China is the biggest holder of U.S. Treasurys since replacing Japan over 10 years ago (Japan is currently No. 2 with $1.08 trillion held). China has been one of the biggest consumers of U.S. debt and an enabler in Washington’s recent ramp-up of debt issuances. And last year, when Beijing officials threatened to halt Treasury purchases, the bond markets were temporarily spooked.

The biggest risk—conceptually—is that the United States is staring down $1 trillion in annual budget deficits, and if China suddenly stops being such a willing lender, borrowing costs could rise.

But some analysts have ignored the fact that while China trimmed its holdings in March, other foreign ownership actually increased. Japan increased its net holdings by $10 billion, and overseas investors overall snapped up about $88 billion in March. The buying activity is no doubt buoyed by the fact that Treasurys overall rallied during March, due to volatility in the equity markets, with the 10-year benchmark touching a 2019 low point of 2.34 percent at one point (bond price moves inversely with yield).

Selling Would Prove Counterproductive

That’s one of the biggest deterrents to China’s fire sale of Treasurys—there is nowhere else for China or other countries to store their money. U.S. bonds are the highest-yielding in the developed world, especially considering the near-zero risk of default. And it has a deep and liquid market.

The two biggest rivals to U.S. Treasurys are German bonds and Japanese government bonds. But both of those papers lack the depth of market and variety of terms, and perhaps the biggest limitations are their negative yields for terms less than 10 years. Gold is an alternative for China and it has been slowly increasing its allocation, but gold is far less liquid and has high carrying costs. In addition, there simply isn’t enough gold supply for China to quickly replace a sizable portion of its $1.12 trillion in Treasurys.

And if mainstream economists are correct that the U.S. economy is in its late-cycle, then Treasury prices will rise over the next few years, should a recession hit. In other words, if China chooses to become a large seller there should be more than enough potential willing buyers.

What about the exchange rate? Dumping Treasurys would put downward pressure on the U.S. dollar. A weaker dollar would make U.S. corporations more productive internationally and lower costs of U.S. goods, potentially decreasing the effectiveness of China’s tariffs on American-made products.

If China does go through with its threat, even assuming few other foreign buyers, the Federal Reserve alone should be able to mitigate its impact.

A study of the Fed’s quantitative easing following the last financial crisis—its systematic purchases of Treasurys—produced some salient data points. Each purchase of Treasurys amounting to 10 percent of GDP produced a 50-basis point (0.5 percent) decrease in the 10-year Treasury bond yields, according to a 2016 research report by the Peterson Institute for International Economics.

In other words, purchases of Treasurys by central banks equating to 1 percent of GDP would typically cause a 5-basis point decrease in bond yields. Assuming the same dynamic applies to selling bonds—quantitative tightening—we can predict the impact of a Chinese bond sale.

Liquidating all its Treasury holdings amounts to selling bonds worth almost 6 percent of U.S. GDP. Based on the above, this would increase Treasury yields by around 30 basis points, or 0.3 percent. And that quantum is well within the ability of the Fed to cure—it would simply swing into quantitative easing mode and snap up the bonds.