Will China dump its US debt amid ongoing trade war?


President Trump has threatened to slap a 25% tariff on the remaining $325 billion in goods coming from China, announcing the plans the same day the US more than doubled duties on $200 billion in Chinese goods as trade talks ended in a deadlock. China has a potential trump card of its own via its massive pile of US debt. But will it use it?

On Saturday, Trump doubled down on his promises to work to eliminate the trade deficit with China, warning that the trade deal between the two countries would “become far worse” for Beijing if it had to be negotiated in his second term and telling the Chinese not to daydream about him being defeated in the 2020 election so that a Democrat may give them a better agreement.

Trump made the comments a day after his administration increased tariffs from 10 to 25% on $200 billion in Chinese imports, just hours before a second day of trade talks in Washington with China’s top trade negotiator.

The US president has repeatedly boasted that the trade deficit with China, estimated to have reached over $220 billion in 2018, gave the US a huge advantage when it came to the tariff war, with the US effectively able to waiting Beijing out as it lost billions as the US Treasury collected tariffs.
However, according to The South China Morning Post, China has its own “range of financial firepower at its disposal to punish the US” for the tariffs war, including its massive $1.123 trillion piggybank of US Treasury bills.

Theoretically, if China were to dump this debt onto the market, US bond prices would drop and force the government to substantially increase yields. That, in turn, would make loans for US corporations and private borrowers more expensive, cooling US growth.

However, Cliff Tan, Tokyo head of global market research at MUFG Bank, told SCMP that China would unlikely to do this, since such a “risky” move would result in “extreme” market volatility.

“Dumping treasuries would be an ineffective weapon for China as that would send yields higher and hurt the positions of their own holdings in treasuries,” Tan explained.

Betty Rui Wang, a senior China economist at the Australia and New Zealand Banking Group, was similarly pessimistic about the idea, suggesting that “China is unlikely to find alternative investment options given that it holds so much.”
Furthermore, SCMP noted that if China sold the treasuries and bought oil instead, energy producers receiving dollars could simply put them back into US Treasuries, thus limiting the ‘punishment’s’ efficacy.

According to Tan, a more effective option for China may simply be allow for the yuan to depreciate against the dollar to offset the negative impact of the increased tariffs to keep Chinese exports competitive in the US market.

Several US administrations have demanded that China limit the depreciation of the yuan, with President Trump accusing Beijing of deliberately manipulating its currency to outcompete US producers. If US tariff policy remains unchanged, Chinese authorities may simply disregard US requests in future.