China’s Nuclear Option To Sell US Treasurys

There is a drumbeat pounding on a monetary issue, which is now rising into a crescendo. The issue is: China might sell its holdings of Treasury bonds—well over $1 trillion—and crash the Treasury bond market. Since the interest rate is inverse to the bond price, a crash of the price would be a skyrocket of the rate. The US government would face spiraling costs of servicing its debt, and quickly collapse into bankruptcy. America could follow the path taken by Venezuela or Zimbabwe.

How serious is this threat?

The Independent Institute wrote (replete with a graphic purportedly showing a “nuclear bomb”) about it:

What would happen if the Chinese government were to weaponize its holdings of U.S. Treasury bonds by suddenly selling off all of them?
That’s an option that has been suggested by Hu Xijin, the editor of the government-controlled Global Times.
Dumping its U.S. national debt holdings is considered to be China’s “nuclear option” for retaliating against the U.S. government in the trade war…

The Financial Time headline says it all: “China dumps US Treasuries at fastest pace in two years”. The body of the article uses that word “weaponize” (British spelling).

Bloomberg warns that “Trade Feud Has Treasury Investors Eyeing China’s Holdings at Fed”. At least their article does not reiterate “weaponized”.

CNBC adds a new element, that is killing America, China would be destroying itself too. The article uses the word “weapon”, as well as calling it the “nuclear option.”

Capital Outflows

Ambrose Evans-Pritchard at the Telegraph is one of the few voices looking at the “accelerating pace of capital outflows from China”. He provides lots of good analysis that we would say is common sense, except it is presently uncommon (yes, yes, we know that common, here, refers to base logic not ubiquity). Capital outflows are due to foreign investors fearing the impact to Chinese corporate profitability from Trump’s tariffs, and Chinese corporations raising US dollars to avert potential defaults.

All around the world, businesses borrow US dollars. They must somehow earn dollar revenue to service this debt. A trade war reduces the volume of trade, and can crush the profitability of the trade that survives. Therefore it makes dollar debtors more desperate for dollars.

To Evans-Pritchard’s list, we would add one more driver. From many informal conversations, we have had, we see a picture of high net individuals seeking to move capital out of the yuan. This outflow, by the way, risks rupturing Hong Kong’s currency peg, managed by its currency board (one of the darling ideas of monetary central planning).

Today, we want to cover the point that China can’t sell Treasurys, because it would hurt itself. China would suffer some pretty severe powder burns if it were to fire this weapon. And next week, we will prove our main point: although China might affect the price of USD against whatever other currency it might buy, it cannot affect the interest rate.

Self-Inflicted Wounds

Selling of the USD is simply China taking the other side of the trade, of those who are selling yuan to buy dollars. China does not want the yuan to collapse, so when there is heavy selling pressure it steps up as the buyer. Which means selling its dollar reserves. The price of the yuan is under China’s control, so long as its dollar reserves hold out. If it runs out of dollars, then that is when the world will discover what the market value of the yuan really is. Its dollar holdings are a precious reserve that it needs to marshal carefully, not squander.

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