China has begun to sell its vast holdings of U.S. Treasury bonds. The action taps into years of media scare stories about the damage a Chinese selloff could do to financial markets, to Washington’s finances, and to the economy generally. Now the Chinese sales have begun. Indeed, in just the last few weeks, Beijing has sold off 10 percent of its entire holdings of treasuries. So far, the disaster described in these many articles has failed to happen. Markets, as it turns out, have hardly noticed the Chinese sales. The fact is that America was never as vulnerable as media stories suggested and that the recent sales are mostly a reflection of Chinese weakness and not American vulnerability.
For anyone who understands how bond markets work, it should have been apparent that China never presented the kinds of risk peddled by these scare stories. Bonds seldom have the characteristics of a home mortgage or a factored warehouse inventory. Especially U.S. Treasury bonds never have a direct connection to a real asset. China never had the option to use its bonds to foreclose, as some suggested, there was never a chance of demand repayment or else. The bondholders only recourse is what China is doing now, selling the bonds to others on open financial markets.
The sale of a lot of bonds theoretically could have driven down their price and hurt other existing bondholders, but China would suffer, too, in such a situation, having to sell its holdings at ever lower prices. No doubt Beijing is delighted that no one noticed its sales. To be sure, the price decline would force higher interest rates on future Treasury borrowing, but it would also offer Washington a boon — the opportunity to buy back its own debt at discounted prices. Effectively, China, if it had shocked markets, would have hurt itself and at the same time offer Washington an opportunity for gain. (Not that the U.S. Treasury would have taken advantage of such an opportunity.)
Even this mild market potential (at least relative to what some media stories described) remains beyond China’s power. Though Beijing’s treasury holdings are indeed large, they have never been large enough to cause much disruption. At their peak, they amounted to about $100 billion, close to holdings in Japan, another famous buyer of U.S. Treasury bonds. Big as this number looks, it amounted to a mere 1.3 percent of the $7.4 trillion of Treasury bonds held outside the United States and a minuscule part of the over $32 trillion in outstanding U.S. Treasury debt, largely held by the American public. China’s peak holdings are not even a significant part of the $600 or so billion in daily trading in treasuries. So there never was a chance for China to create anything more than a minor price disruption. The lack of turmoil as China sold 10 percent of its holdings simply underlines this fact.
Beijing’s financial people surely understood the situation. They always knew that sales could not possibly have the kind of effects described in fearful western media treatments, though they surely must have enjoyed the perception of power such speculation brought them. If not to hurt America, why then is Beijing selling off its U.S. Treasury bond holdings?
Some in the foreign affairs community have suggested that it is a warning to Washington about its support for Taiwan. That seems unlikely on at least two counts. First, what
China has done with these initial sales has had so little effect that it hardly could intimidate U.S. officials about what China might yet do. Second, Beijing has no difficulty with more direct threats, such as violations of Taiwanese air space and harassment of U.S. aircraft and naval vessels. Taiwan is a matter of great diplomatic concern and no doubt a matter of great interest within the foreign affairs community, but it is hardly a reason for China to sell off its dollar bond holdings.
What is more likely — and more a reflection of Chinese weakness than American vulnerability — is that China simply needs the money. Though its economy still runs a trade surplus, it is no longer as large as it was, absolutely and certainly relative to China’s needs. Beijing’s Belt and Road initiative and other foreign ventures have not only drawn heavily on the funds brought in by the trade surplus, but they have pushed China to amass the equivalent of $1.5 trillion in debts denominated in foreign currencies, half of which are scheduled to mature in the next twelve months or so. Already, China’s foreign exchange reserves have shrunk from a peak of $3.25 trillion to $3.07 trillion. If last year is an indication, China will have to shoulder some $600-$700 billion of essential imports, such as oil, computer chips, iron ore, animal feed and foodstuffs for its people. The strain has already forced Beijing to pull back on its Belt and Road project, including investments in Southeast Asia, effectively its own backyard.
On a still more fundamental level, the sales of treasuries may reflect Beijing’s realization that its former and once very successful economic model may have run its course. For decades, China’s cheap, reliable labor drew foreign investment funds into the country and allowed China-built products to outcompete others in global markets. The United States was a major consumer. But because the Americans were running a trade deficit, they needed to borrow to support the purchase of these Chinese imports. China advanced that loan indirectly through its purchases of U.S. Treasury bonds. Beijing knew that it lost money on the bonds but kept up the lending because it more than made up the loss with the profits on its exports.
But Chinese wages have begun to catch up with the developed world and have outstripped wages elsewhere — in India, for example, Southeast Asia, and Latin America. At the same time, China’s behavior during the pandemic raised questions about its reliability as a partner in global supply chains. On top of these considerations, President Xi Jinping’s increasingly authoritative and bullying moves have made it more and more difficult for foreigners to do business in China. China old economic model no longer works. Though it is not yet clear how Beijing will remake its economic model, the need clearly exists and lending to Americans to buy Chinese exports clearly has a limited future in it.
The need for money to support China’s ongoing economic imperatives and the parallel need for Beijing to remake the country’s economic model now render pointless Beijing’s huge holdings of U.S. Treasury bonds. The selling will no doubt continue. It will not rock financial markets and certainly not lead to the scary stories peddled in so many past articles about China’s portfolio of U.S government debt.
