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Could Trade Conflict Cause China to Sell Its U.S. Treasuries?

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KATHY JONES: Ever since the trade conflict between the U.S. and China began, there have been concerns that China might threaten to sell its large holdings of U.S. treasury bonds to put pressure on the U.S. That would have negative implications for the markets.

I’m Kathy Jones and this is Bond Market Today.

We think it’s very unlikely that China would use its treasury holdings as a weapon in the trade dispute because the consequences of selling its holdings of U.S. treasuries would probably backfire and be just as harmful to the Chinese economy as it would to the U.S.

China holds over a trillion in U.S. dollar reserves, making it the largest foreign holder of U.S. treasuries outside the United States. Now, Japan is close behind, however, with almost as much. China has accumulated these dollar reserves as a result of their large trade surplus and high savings rate. China sells more goods than it takes in, and therefore runs a surplus. Since most globally traded goods are traded in U.S. dollars, it accumulates that surplus in the form of dollars. It uses some of those dollars for imports, so such things like soybeans and corn and oil, which are also traded in U.S. dollars, but to the extent that they have excess reserves, they usually invest them in U.S. treasuries. They choose to put them in treasuries because it’s a large and liquid market that’s considered safe. In other words, China can get a hold of those funds at any time they need to.

We don’t think that China is likely to sell those treasuries to put pressure on the U.S. because it could be harmful to China in three ways. Firstly, it could make the value of China’s currency, the yuan, move up relative to the dollar and that would hurt its exporters because its goods would be priced less competitively. Secondly, selling those treasuries would probably make U.S. interest rates go up, hurting the U.S. economy, and since the U.S. is one of China’s biggest customers, the U.S. would be less inclined or less able to purchase goods from China, and that would hurt its exporters as well.

And then lastly, it would leave China with a problem of where to invest their excess reserves. If they’re not investing in the U.S. market, they have to find someplace to put those dollars, and if they convert them to other currency then they have to find a bond market that’s large enough to absorb those holdings, and it’s really difficult to see what market could absorb a trillion dollars’ worth of reserves. When we look around the developed markets, their bond markets tend to be smaller, and right now their interest rates are zero or close to zero or even negative, so China would be giving up a positive return on its investment.

The bottom line is that since China and the U.S. are so intertwined in terms of trade and investment, a move by China to sell off its treasury holdings would do as much damage to China as it would the U.S. economy.

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Ever since the trade conflict between the U.S. and China began, there have been concerns that China might threaten to sell its large holdings of U.S. treasury bonds to put pressure on the U.S. That would have negative implications for the markets.

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