This story is being published by POLITICO as part of a content partnership with the South China Morning Post. It originally appeared on scmp.com on May 10, 2019.
China’s promise to strike back after U.S. President Donald Trump increased tariffs on US$200 billion worth of Chinese goods on Friday has heightened uncertainty on how escalating trade tensions between the two countries will unravel and raised fears among investors and analysts of worst-case scenarios that will hurt global growth.
If China was unwilling to play ball on Trump’s terms, Beijing, analysts said, not only could retaliate by imposing countervailing tariffs of its own, but it also has a range of financial arsenal power at its disposal to punish the U.S.
For starters, China could fire back by dumping its vast holdings of U.S. government debt. Flooding the market with treasuries would push down US bond prices and cause the yields to spike. That would make it more costly for U.S. companies and consumers to borrow, in turn depressing America’s economic growth.
Cliff Tan, East Asian head of global markets research at MUFG Bank said it was unlikely that China would choose to scale back its holdings in U.S. treasuries sharply as that would hurt its own interests and fuel “extreme” market volatility.
“Dumping treasuries would be an ineffective weapon for China as that would send yields higher and hurt the positions of their own holdings in treasuries,” said Tan.
“If China got out of U.S. dollar assets completely, it would be very risky to them because of extreme market volatility.”
The trade war had seemed on the cusp of ending until Sunday when Trump threatened to raise existing tariffs in a tweet, sending Chinese stocks and its currency lower this week. The benchmark Shanghai Composite Index touched its lowest level in 10 weeks while the yuan is heading for its biggest weekly decline since mid-2018.
Minutes after the U.S. raised tariffs from 10 percent to 25 percent on Friday, the Ministry of Commerce reiterated its tough stance in the trade war, saying in a statement, “we’ll have no choice but to take the necessary countermeasures”.
Nonetheless, the statement said Beijing remained hopeful to resolve the problem “through cooperation and negotiations”. Vice-Premier Liu He has been in Washington since Thursday for two-day of trade talks. Talks will resume on Friday morning in Washington.
Up until 2016, the People’s Bank of China was buying U.S. dollars from exporters while selling yuan to them to prevent the Chinese currency’s excessive appreciation. Most of China’s US$3.1 trillion in foreign exchange reserves, the world’s largest, is parked with U.S. Treasury securities, which have a safe haven status. China needs the U.S. dollar assets as a safety buffer should it need to bail out the domestic banking system or to support the yuan through foreign exchange intervention.
Although it has cut its holdings in U.S. Treasuries in recent years, it still takes the top spot among foreign creditors at US$1.123 trillion, followed by Japan with US$1.042 trillion.
The amount, however, is only around 5 per cent of the U.S.’ total debt of US$22 trillion owed by the federal, state and local governments as of February. Of the total, more than US$5 trillion debt is actually owned by the federal government in trust funds dedicated to social security. Much of the rest of the debt is owned by individual investors, corporations and other public entities, including the Chinese government.
Although US$1.123 trillion is by no means a small amount, it accounts for just around 5 percent of the U.S.’ national debt and remains to be seen if China’s paring back of its holdings would lead to any effective results.
“Dumping treasuries is unlikely to be an effective move for trade war negotiations. China is unlikely to find alternative investment options given that it holds so much treasuries,” said Betty Rui Wang, senior China economist at ANZ Bank.
Still, if China decided to sell U.S. treasuries and bought oil, oil producers who receive the U.S. dollars may channel them back into U.S. treasuries, which would not increase China’s leverage to protect its interests.
MUFG’s Tan said a better option for China would be to allow the yuan to depreciate against the U.S. dollar to offset the negative impact of the tariffs.
But this week’s decline in the yuan’s exchange rate dashed hopes that Beijing would fulfill U.S. demands to keep its currency stable at all costs.
“If there is no currency stability pact negotiated, then this is certainly one way China can prepare for what we think is going to be pretty serious escalation of tariffs,” Tan said.
The latest round of tariff increase to 25 percent by the Trump administration now matches the rate imposed on a prior US$50 billion category of Chinese machinery and technology goods. Trump has also threatened 25 percent tariffs on possibly another US$300 billion worth of Chinese goods.
Article originally published on POLITICO Magazine
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The Article Was Written/Published By: Karen Yeung | South China Morning Post