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China could cut US debt holdings in response to White House Covid-19 compensation threats, analysts say
China may move to reduce its vast holdings of US Treasury securities in the coming months in response to a resurgence in trade tensions and a war of words between the world’s two largest economies over the origins and handling of the coronavirus outbreak, analysts said.
US news reports indicated that White House officials have debated several measures to offset the cost of the coronavirus outbreak, including cancelling some or all of the nearly US$1.1 trillion debt that the United States government owes China.
While analysts added that the US was highly unlikely to take the “nuclear option”, the mere fact that the idea has been discussed could well prompt Beijing to seek to insulate itself from the risk by reducing its US government debt holdings.
That, in turn, could spell trouble for the US government bond market at a time when Washington is significantly ramping up new issuance to pay for a series of programmes to combat the pandemic and the economic damage it is causing.
"It's such a crazy idea that anyone who has made it should really have their fitness for office reconsidered"
“It's such a crazy idea that anyone who has made it should really have their fitness for office reconsidered,” said Cliff Tan, East Asian head of global markets research at MUFG Bank. “We view this as largely a political ploy for [Donald Trump’s] re-election and a cynical one because it would destroy the financing of the US federal budget deficit.”
The discussion of China’s financial connection to the US government has come about as US President Donald Trump and other American officials have ramped up their criticism of Beijing over the coronavirus outbreak and threatened new import tariffs to penalise China.
But any move to cancel the debt owed to China – effectively defaulting on it – would be counterproductive to US interests because it would likely destroy investors’ faith in the trustworthiness of the US government to pay its bills, analysts warned.
This would send US interest rates soaring, making borrowing more costly for the government, as well US companies and consumers, and in turn strike a sharp blow to America’s already very weak economy.
The US Treasury two-year yield continued to trade near record low levels this week, suggesting market traders and fund managers are largely shrugging off what is widely seen as a far-fetched idea that the US could cancel some or all of China’s debt.
Nevertheless, the news that the idea was discussed by top US officials is likely to raise concerns among Chinese leaders about the growing risks of holding a large amount of US government debt at a time when relations appear to be deteriorating rapidly, analysts said.
Iris Pang, Greater China chief economist at ING Bank, said unless it had no choice, China would want to avoid quickly offloading its US government debt without first considering other punitive measures against the US.
In the past decade, there has been no shortage of calls in China for the government to dump its vast holdings of US Treasuries.
"In the coming months, [China could] halt its Treasury purchases to send a clear signal of its intentions"
China could trigger a crash in the US dollar and financial markets by flooding the market with US Treasuries for sale, which would push down US bond prices and cause yields to spike. But that would also ignite a global financial catastrophe, hurting China as well.
Instead, China could cut back or stop buying new US Treasury issues, which would gradually reduce its holdings of US government securities as old ones expire and are not replaced.
“In the coming months, [China could] halt its Treasury purchases to send a clear signal of its intentions,” said Pang. “If it decides to do that, it could make actual sales [of its other holdings] at a later date.”
In the meantime, China may consider imposing tariffs of its own, or reducing its US agricultural purchases. China has agreed to buy an additional US$200 billion worth of US products and services over the next two years compared to 2017 levels as part of the phase one trade deal signed in January. But the coronavirus outbreak has already raised questions about China’s ability to meet these commitments, while Trump said on Sunday that he would terminate the deal if China does not buy the amount of American products it has promised.
"This is simply because the US dollar can be weaponised by the US government"
China legal experts have also started studying the feasibility and risks of suing the US government for its actions in the past two weeks, Zhu Ying, deputy director of the National Human Rights Education and Training Base at the Southwest University of Political Science and Law in Chongqing, was cited by the government-backed Global Times as saying.
There have always been calls for China to diversify its US$3 trillion in foreign exchange reserve holdings, around one-third of which are held in US Treasuries. According to the latest US Treasury Department report, China’s holdings slipped to US$1.09 trillion in February from a peak of US$1.32 trillion in November 2013. China was surpassed by Japan last year as the largest foreign holder of US Treasuries.
“There's a strong urge for countries like China, and Russia, to move away from US dollar settlements. This is simply because the US dollar can be weaponised by the US government,” said Xu Sitao, chief economist at Deloitte China, referring to the recent practise by the US government of cutting off foreign individuals, companies and governments from the global US dollar financial transaction settlement system, greatly complicating their ability to conduct business.
“Clearly there's more willingness for certain countries just to diversify and move away from US dollar settlements.”
China’s foreign exchange regulator, the State Administration of Foreign Exchange, last year revealed a snapshot of the composition of China’s foreign exchange reserves as of 2014, showing that it had been steadily diversifying its holdings away from US dollar denominated assets and into other riskier currencies as well as gold.
US dollar assets accounted for 58 per cent of China’s total US$3.84 trillion in reserves at the end of 2014, down from 79 per cent in 2005 and below the global average of 65 per cent.
In a recent research note, Goldman Sachs analyst Karen Reichgott Fishman estimated that China sold around US$30 billion in US dollar-denominated assets in March to defend the yuan’s exchange rate from the sharp US dollar appreciation that month. China's foreign exchange reserves fell significantly in March 2020, the biggest fall since November 2016.
Fishman assumed China’s US dollar-denominated holdings consisted of 70 per cent US Treasuries, 15 per cent US government agency debt and 15 per cent equities.
David Chin, the founder of Basis Point Consulting, said China could be forced to toughen up its act if it no longer earned US dollars from its exports to the US because of a significant US-China decoupling. If that were to happen, China could sell its US Treasury holdings for yuan, seeking to engineer a collapse in the US dollar to end its status as the ruling currency.
“Its ‘I die, you die harder’,” Chin said. “With no US export market, China would go the other way and rely on internal consumption, trade with Belt and Road countries and the rest of the world in their local currencies, and prepare to ‘eat bitter’ as local conditions worsen.”
- US news reports suggest White House officials have already considered the idea of cancelling all or part of the US$1.1 trillion debt owed to China
- In response to the debate over the highly unlikely ‘nuclear option’, China could cut its holdings as the US ramps up borrowing to pay coronavirus-related costs
China may move to reduce its vast holdings of US Treasury securities in the coming months in response to a resurgence in trade tensions and a war of words between the world’s two largest economies over the origins and handling of the coronavirus outbreak, analysts said.
US news reports indicated that White House officials have debated several measures to offset the cost of the coronavirus outbreak, including cancelling some or all of the nearly US$1.1 trillion debt that the United States government owes China.
While analysts added that the US was highly unlikely to take the “nuclear option”, the mere fact that the idea has been discussed could well prompt Beijing to seek to insulate itself from the risk by reducing its US government debt holdings.
That, in turn, could spell trouble for the US government bond market at a time when Washington is significantly ramping up new issuance to pay for a series of programmes to combat the pandemic and the economic damage it is causing.
"It's such a crazy idea that anyone who has made it should really have their fitness for office reconsidered"
“It's such a crazy idea that anyone who has made it should really have their fitness for office reconsidered,” said Cliff Tan, East Asian head of global markets research at MUFG Bank. “We view this as largely a political ploy for [Donald Trump’s] re-election and a cynical one because it would destroy the financing of the US federal budget deficit.”
The discussion of China’s financial connection to the US government has come about as US President Donald Trump and other American officials have ramped up their criticism of Beijing over the coronavirus outbreak and threatened new import tariffs to penalise China.
But any move to cancel the debt owed to China – effectively defaulting on it – would be counterproductive to US interests because it would likely destroy investors’ faith in the trustworthiness of the US government to pay its bills, analysts warned.
This would send US interest rates soaring, making borrowing more costly for the government, as well US companies and consumers, and in turn strike a sharp blow to America’s already very weak economy.
The US Treasury two-year yield continued to trade near record low levels this week, suggesting market traders and fund managers are largely shrugging off what is widely seen as a far-fetched idea that the US could cancel some or all of China’s debt.
Nevertheless, the news that the idea was discussed by top US officials is likely to raise concerns among Chinese leaders about the growing risks of holding a large amount of US government debt at a time when relations appear to be deteriorating rapidly, analysts said.
Iris Pang, Greater China chief economist at ING Bank, said unless it had no choice, China would want to avoid quickly offloading its US government debt without first considering other punitive measures against the US.
In the past decade, there has been no shortage of calls in China for the government to dump its vast holdings of US Treasuries.
"In the coming months, [China could] halt its Treasury purchases to send a clear signal of its intentions"
China could trigger a crash in the US dollar and financial markets by flooding the market with US Treasuries for sale, which would push down US bond prices and cause yields to spike. But that would also ignite a global financial catastrophe, hurting China as well.
Instead, China could cut back or stop buying new US Treasury issues, which would gradually reduce its holdings of US government securities as old ones expire and are not replaced.
“In the coming months, [China could] halt its Treasury purchases to send a clear signal of its intentions,” said Pang. “If it decides to do that, it could make actual sales [of its other holdings] at a later date.”
In the meantime, China may consider imposing tariffs of its own, or reducing its US agricultural purchases. China has agreed to buy an additional US$200 billion worth of US products and services over the next two years compared to 2017 levels as part of the phase one trade deal signed in January. But the coronavirus outbreak has already raised questions about China’s ability to meet these commitments, while Trump said on Sunday that he would terminate the deal if China does not buy the amount of American products it has promised.
"This is simply because the US dollar can be weaponised by the US government"
China legal experts have also started studying the feasibility and risks of suing the US government for its actions in the past two weeks, Zhu Ying, deputy director of the National Human Rights Education and Training Base at the Southwest University of Political Science and Law in Chongqing, was cited by the government-backed Global Times as saying.
There have always been calls for China to diversify its US$3 trillion in foreign exchange reserve holdings, around one-third of which are held in US Treasuries. According to the latest US Treasury Department report, China’s holdings slipped to US$1.09 trillion in February from a peak of US$1.32 trillion in November 2013. China was surpassed by Japan last year as the largest foreign holder of US Treasuries.
“There's a strong urge for countries like China, and Russia, to move away from US dollar settlements. This is simply because the US dollar can be weaponised by the US government,” said Xu Sitao, chief economist at Deloitte China, referring to the recent practise by the US government of cutting off foreign individuals, companies and governments from the global US dollar financial transaction settlement system, greatly complicating their ability to conduct business.
“Clearly there's more willingness for certain countries just to diversify and move away from US dollar settlements.”
China’s foreign exchange regulator, the State Administration of Foreign Exchange, last year revealed a snapshot of the composition of China’s foreign exchange reserves as of 2014, showing that it had been steadily diversifying its holdings away from US dollar denominated assets and into other riskier currencies as well as gold.
US dollar assets accounted for 58 per cent of China’s total US$3.84 trillion in reserves at the end of 2014, down from 79 per cent in 2005 and below the global average of 65 per cent.
In a recent research note, Goldman Sachs analyst Karen Reichgott Fishman estimated that China sold around US$30 billion in US dollar-denominated assets in March to defend the yuan’s exchange rate from the sharp US dollar appreciation that month. China's foreign exchange reserves fell significantly in March 2020, the biggest fall since November 2016.
Fishman assumed China’s US dollar-denominated holdings consisted of 70 per cent US Treasuries, 15 per cent US government agency debt and 15 per cent equities.
David Chin, the founder of Basis Point Consulting, said China could be forced to toughen up its act if it no longer earned US dollars from its exports to the US because of a significant US-China decoupling. If that were to happen, China could sell its US Treasury holdings for yuan, seeking to engineer a collapse in the US dollar to end its status as the ruling currency.
“Its ‘I die, you die harder’,” Chin said. “With no US export market, China would go the other way and rely on internal consumption, trade with Belt and Road countries and the rest of the world in their local currencies, and prepare to ‘eat bitter’ as local conditions worsen.”
