If a major trade war breaks out between China and the U.S., the Chinese government has a major weapon in the $1.2 trillion in Treasury securities it owns.
As President Trump has traded tariff threats with China in the past weeks, some economists and investors have raised the prospect of China eventually retaliating by dumping some of its vast holdings of Treasury bonds.
Such a move, in theory, would hurt the U.S. government by raising its cost of borrowing. Spiking Treasury yields also could cause disruption in financial markets.
While it’s unlikely that China would resort to such an assault, it’s a prospect that investors have been discussing, according to Donald Ellenberger, a senior vice president at Federated Investors, a Pittsburgh-headquartered investment manager.
The reason it can’t be ignored is that China has the largest portfolio of U.S. Treasury securities of any foreign nation. Japan is not far behind, with $1.1 trillion in holdings, but since 2008 China has typically been the bigger lender to Uncle Sam.
If China were to suddenly sell off Treasurys, the ensuing higher interest rates could, in theory, become a serious problem for the debt. Today, the Treasury pays relatively little in interest because rates are so low, even though the debt is high.
“If interest rates are higher or lower, that will make a pretty big impact on where we are with respect to debt in 10 years,” Congressional Budget Office Director Keith Hall said Monday.
Paradoxically, though, China dumping bonds could actually lead to lower Treasury rates. The reason is that it it would be part of a larger trade war that would hurt the economy, and a bad economy leads investors to try to park their money in the safest asset available — Treasurys.
“I think a full-blown trade war with China selling Treasurys, I think that would be unquestionably bad for stock markets,” Ellenberger said.
Just as likely, though, is that Chinese sales of Treasurys wouldn’t much affect the vast market. In 2016, the government sold large batches of Treasurys to try to prop up its weakening currency, while Treasury rates declined, Ellenberger noted.
Last week, Chinese Finance Minister Zhu Guangyao downplayed the possibility that China would dump Treasurys as part of any trade dispute, saying his country is a “responsible investor.”
Doing so wouldn’t make much sense from China’s perspective, according to Joseph Gagnon, a fellow at the Peterson Institute for International Economics and former Federal Reserve official. By selling some Treasurys, China would be lowering the value of its remaining portfolio of Treasurys. “They’d be shooting themselves in the foot somewhat,” he said.
And, of course, the biggest player in the $20.5 trillion Treasury market is the Federal Reserve, which has about $2.9 trillion in Treasurys in its portfolio. The Fed has the ability and mandate to keep interest rates steady, limiting the ability of China’s actions to affect rates, he said.
Incoming Federal Reserve Bank of New York President John Williams brushed aside the possibility of China selling off its bonds last week. Doing so would harm the Chinese government’s ability to manage its currency and would hurt its economy, said Williams, according to the Wall Street Journal. Williams, currently the head of the San Francisco Fed, remarked, “They are trapped.”
