China's US debt holdings: Double-edged sword in trade war

As the United States and China threaten each other with tit-for-tat tariffs, some say Beijing could use other weapons such as devaluing the yuan. (Photo: AFP/Fred Dufour)

Donald Trump last month sparked fears of a potentially destabilising stand-off between the world's top two economies after threatening tariffs on Chinese imports, leading to warnings of tit-for-tat measures against hundreds of billions of dollars worth of goods.

But while the talk focuses on the levies, there are mutterings within Beijing that President Xi Jinping should turn his attention to other weapons at his disposal.

Fan Gang, a member of the Chinese central bank's monetary policy committee, hinted Sunday Beijing could stop buying US Treasuries.

"These assets need to be properly used, investing in US government bonds is not as good as investing in some real assets," he told an economic forum, according to the Caixin financial magazine.

Those comments followed a report in the nationalist Global Times tabloid quoting researcher Huo Jianguo of the Center for China and Globalization, who threatened "if we sell $200 billion US debts, that would definitely put significant pressure on the US financial market".

GOOD IDEA?

And on Monday, Bloomberg News, citing anonymous sources, reported that Chinese officials were studying pushing currency devaluation as one potential option to take on the US's tariffs.

On the face of it, selling Treasuries would seem like a good idea.

China is the biggest holder of US debt - US$1.17 trillion as of January - built up over decades as leaders looked to diversify their bulging surpluses safely as the economy expanded at breakneck speed.

Those investments help grease the cogs of the titanic US economy, paying for crucial services and infrastructure as well as Trump's US$1.5 trillion tax cuts passed in December.

With billions coming in, only the US's financial markets are deep and liquid enough for Beijing to invest in, while the purchases also allow China to control the value of its renminbi currency.

Biggest foreign holders of US treasury bonds. (Graphic: AFP/Gal Roma)

Michael Pettis, at Peking University's Guanghua School of Management, said if China were to cut its purchases "such a step cannot credibly be seen as meaningful retaliation against rising trade protectionism in the United States."

"Beijing's decision would either have no impact at all on the US balance of payments, or it would have a positive impact."

If the US wants to shrink its trade deficit, then due to the balance of payments it needs to shrink the surplus in its capital account - the investment flows coming into the country, Pettis said. China's Treasury purchases do the opposite, he said, growing the US's capital account surplus.

He added that if China stopped buying Treasuries or sold them it would then have to either buy euros or yen, however the Japanese and Europeans would also not want to run a deficit with Beijing.

The other option is to let the renminbi appreciate, which would eventually reduce the trade surplus with the US as China would export less and import more.

Nor would selling send US interest rates soaring, analysts say.

They point to China's selloff in 2016, when over several months it reduced its position by US$200 billion as it defended its currency, and US Treasury yields dropped.

'ONLY GAME IN TOWN'

A more abrupt selloff could cause instability but it would also hit the value of China's remaining US holdings, said Stephen Innes, head of trading for OANDA in the Asia Pacific.

"US bonds are the only game in town for China so it's very unlikely they will go down that road," he added.

In a news conference last week, China's vice finance minister Zhu Guangyao also poured cold water on the idea of selling US debt.

The principle of China's US$3 trillion foreign currency reserves is first and foremost safety, Zhu said, noting "China is a responsible investor in international capital markets".

Devaluing the renminbi, or yuan, may be another way for Beijing to subvert any Trump tariffs while sticking it to the US as a way of offsetting any increase in prices caused by import taxes.

But the new head of the central People's Bank of China, Yi Gang, maintained on Wednesday that Beijing would not resort to such a move.

Trump has railed against China for keeping its currency undervalued, though his administration has yet to take the formal step of labelling Beijing a currency manipulator.

China has been working to rebalance its economy away from the export and investment heavy model that has driven four decades of growth but left Beijing deeply in debt.

Beijing is counting on its 1.4 billion consumers to fire the economy, but experts say driving down the value of the yuan would push that goal further into the future.

"Every household in the world imports directly or indirectly," said Pettis.

"If you depreciate the currency you increase the price of imports, so that means for your income level you can buy less."