What Happens If China Triggers Its Nuclear Option for U.S. National Debt?

The U.S. government directly owes the nation of China over 1.1 trillion dollars. 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 between the two countries that has been going on for more than a year. CNBC‘s Jeff Cox describes how Beijing might come to deploy this particular economic weapon in its trade war with the United States:

As the two sides engage in a tit-for-tat tariff exchange, the possibility that China might raise the stakes and stop being the world’s biggest consumer of U.S. debt again reared its imposing head Monday.

China currently owns $1.13 trillion in Treasurys, a fraction of the total $22 trillion in U.S. debt outstanding but 17.7% of the various securities held by foreign governments, according to data from the Treasury and the Securities Industry and Financial Markets Association. Should the Chinese decide to walk away or reduce their role in the market, that, at least in theory, could create a substantial dislocation for a country such as the U.S. that relies so much on sovereign entities to buy its paper….

“To me, that is the biggest worry. This is really the biggest weapon they have,” said Sung Won Sohn, professor of economics at Loyola Marymount University and president of SS Economics. “They need to do more to counter the United States. So if push comes to shove, that’s what they are going to resort to.”

For the United States, China’s dumping of U.S. Treasuries would, in effect, flood the bond market, which would impact the U.S. government’s ability to issue new debt at the low interest rates it desires, forcing up the cost of all its new borrowing. Since the U.S. government is increasing its spending, with annual deficits projected to soon reach more than a trillion dollars, that would push up the day of reckoning for when all the new money it borrows will go to pay the interest owed on all the money it has previously borrowed.

Deploying its “nuclear option” for the U.S. national debt would not be without risk for Beijing, however. Writing at Business Insider, Linette Lopez argues that such a move would “backfire catastrophically”:

… a Treasurys dump would hurt the US, China, and the world, in that order. Selling US Treasurys would depress the value of the dollar, making Chinese exports more expensive. Plus, it would limit China’s ability to manage its own currency, the yuan, if this trade war got really out of control.

China has been using its holdings of foreign currency to maintain the relative buying power of the yuan with respect to the U.S. dollar, which has helped it avoid facing additional retaliation from other nations for currency manipulation if it allowed the yuan to become devalued.

Such a currency devaluation would directly harm Chinese firms, many of whom owe money that will have to be paid back to their lenders in U.S. dollars.

… the economist and former Peking University professor Christopher Balding said, China has $1.3 trillion in US-dollar denominated debt coming due in the next 12 months. If the yuan is weak, paying that back will be more onerous for the country, or rather most specifically, it’s very indebted corporate sector.

These factors make it unlikely that the Chinese government would choose to pursue a path of self-destruction, but that assumes Chinese business and economic interests would be in the driver’s seat when making such a decision. If other interests prevail, what seems to be an otherwise unthinkable action might come to pass, even if China has more to lose from its nuclear option.

Over a year ago, I would have thought an escalating trade war between Washington and Beijing was so unlikely and undesirable that it wouldn’t last long, even in the remote possibility it ever did happen. And yet, here we are.