China's nuclear option

Posted by: Paul Donovan

17 May 2019
  • The US has one very, very successful export to China. The US is great at selling US government bonds to China. US President Trump is taxing Americans to try and stop them from buying goods partially made in China. Might China retaliate by no longer buying US bonds?
  • The Chinese would probably lose money if they sold US bonds. That is not a reason to do it. Central banks hold foreign exchange reserves for political not profit reasons. However there are problems with selling.
  • Politically, dumping Treasuries is a "nuclear option." It would make solving the trade dispute harder. There might be an extreme US reaction – freezing Chinese assets, or capital controls. Practically the problem for China is finding a dollar alternative. The euro area lacks a single liquid bond market. Most Chinese trade is priced in dollars.
  • Nonetheless, China might want to stress the two-way flow to US trade. There were reports that the Japanese might dump Treasury bonds during their early 1990s trade dispute with the US. That worried US markets. Media stories about China possibly selling Treasuries could have the same effect. Missing some bond auctions may also remind the US that Beijing matters as a bond buyer.

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