#China Stands to gain more from keeping US Bonds, not dumping them

When China sold $3 billion worth of its US bond holdings last month, political commentators perceived a thinly-veiled threat: if President Trump persists with his confrontational trade policy, Beijing has the capacity to send the US economy tumbling in the blink of an eye. The truth, however, is more complex - writes Leonardo Gonzalez Dellan

US-China relations have cooled in the past year as President Trump has committed himself to reducing the trade deficit with Beijing. With American tariffs on Chinese imports reaching an excess of $200 billion, the Chinese have responded with their own taxes of $60 billion. The repercussions for financial markets have been notable, including a fall in the sales of Beijing’s own offshore debt. Offsetting this situation is in part what prompted the raising of $3 billion from US bonds.

Beijing is threatening the US with a mass sale of debt. But in the long-term, the Chinese know that that they stand to lose more than the US. In the short-term, the economic consequences for America would be harsh. The sell-off would equate to roughly 6% of the US’s GDP and the Treasury would probably be forced to offer very high interest rates to entice potential buyers. Stock markets would likely crash alongside the price of the dollar. But this is a storm that the US economy could weather. By slowing the rate of hikes in interest rates and introducing measured quantitative easing, the Treasury would be able to counter the sell-off. A fall in the dollar could even end up triggering more advantageous trade terms. China, meanwhile, would lose the billions of dollars it earns each year from US debt interest, as well as billions more from a weakened bond portfolio. Beijing gains far more by maintaining the status quo.

Nevertheless, despite a probable recovery, the US cannot be indifferent to the threat of a $1.17 trillion sell-off.  A slump in financial markets is far more politically damaging to the US government. While only 9% of China’s population have investments, a significant 54% of American citizens own stocks, with many retirement funds tied up with market fortunes. If the President’s trade policy puts people’s savings in jeopardy, there is a political price to pay. It is certainly in Washington’s interests to end the trade war quickly and remove this nuclear threat from its horizon.

The mass sell-off of US bonds is China’s most powerful weapon. Yet it is in no one’s interests for it to be used. By keeping their bonds, the Chinese will know that they are building pressure on Trump. If American trade policy does not become more tempered, Beijing can threaten to sell. In the long run, however, the dust would clear, and America would recover. It is in the US’s interest to de-escalate tensions too. It is not inconceivable for Beijing to use its ‘weapon’, and the political effects in America would be extremely uncomfortable. While the status quo is far from ideal, it leaves the situation both workable and negotiable.

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