68 Finance & economics The EconomistJune 1st 2019
A
n old saying: if you owe the bank $100 it’s your problem; if
you owe $100m it’s the bank’s. The adage is silent on debts like
America’s to China, of more than $1.1trn. The iou looks like a
source of leverage for China’s leadership—a reason for President
Donald Trump to be cautious in waging trade war, lest his counter-
part, Xi Jinping, command the People’s Bank of China (pboc) to
dump its Treasury bonds and plunge America into a fiscal crisis.
An editorial on May 29th in the People’s Daily, a Communist Party
mouthpiece, suggested that China might restrict exports to Ameri-
ca of rare earths, which are used in smartphones, electric vehicles
and much more. Seen against fresh threats, the $20bn-worth of
long-term bonds China sold in March might seem a shot across the
bow. Yet China’s bond pile is more blunderbuss than laser-guided
missile. It is as likely to miss or blow up as to strike its target.
China’s bond-buying began innocently enough. Its leaders, ea-
ger to follow the time-tested path to export-led development, fa-
voured an undervalued currency. In the early 2000s, as rapid
growth in output and exports put upward pressure on the ex-
change rate, the pboc sold yuan and bought dollars, most of which
it parked in American Treasuries. Cheap funding looked like a
boon to America, at the time awash in red ink because of tax cuts
and foreign wars. But as so often with China, something too small
to notice quickly became too large to ignore. China’s official hold-
ings of American government debt rose from just under $100bn in
2002 to a peak of nearly $1.3trn in 2013. It now manages the yuan
against a basket of currencies rather than the dollar alone, and no
longer buys very many Treasuries. But the reserve hoard remains.
Its value as an economic weapon is dubious, however. The
point of a bond dump would be to saturate the market for Treasur-
ies. America’s hefty government debt needs continuous rolling
over, and its stonking deficits add to the pile at a pace of about $1trn
per year. Investors, for now, keep buying. But China, by selling
Treasuries, might ply the market with more bonds than it can easi-
ly digest. To keep overfilled investors coming back, America’s gov-
ernment might need to offer higher interest rates. A big enough
jump in borrowing costs could force it to choose between growth-
crushing fiscal austerity and a fiscal crisis.
But Treasuries are not a typical security. In 2011, for example,Standard& Poor’s, a ratings agency, cut America’s sovereign credit
rating, citing its soaring debt and dysfunctional politics. Markets
promptly gobbled up more Treasuries than ever; the yield on the
ten-year bond soon fell by more than a percentage point. This anti-
gravity effect derives from America’s hegemonic role in finance. It
issues the world’s primary reserve currency and its most prized
safe asset. The always-healthy appetite for American debt grows in
times of economic uncertainty—even when America itself is the
cause of the trouble. If Chinese bond sales rattle global markets,
the flight to safety might well sop up the new Treasury supply.
Even if markets remained calm, Chinese sales might prove a
mere annoyance. An analysis published by the Federal Reserve in
2015 suggested that $1.5trn in bond purchases would be expected to
reduce ten-year Treasury yields by between 40 and 50 basis points.
A comparable rise in yields induced by Chinese bond sales would
be uncomfortable, but hardly a disaster, especially since the Fed
could intervene if rising yields threatened America’s economy.
The Fed is currently shedding $15bn-worth of Treasury bonds each
month as it unwinds the unconventional stimulus measures used
after the financial crisis. Were China to start selling, the Fed could
simply resume buying.
Bond yields are only part of the picture. China bought its Trea-
suries to stop the yuan appreciating too quickly. Were it to sell
them and convert the proceeds back into yuan, its currency would
rise, hurting its already-beleaguered exporters and delighting Mr
Trump. China could instead try to swap its Treasuries for other for-
eign assets. Alas, no other government-bond market matches
America’s for size and safety. German bunds are rock-solid, but in
short supply thanks to German fiscal surpluses. France, Italy and
Japan offer large markets but more risk. All would fume if China
turned its cash their way, causing their currencies to appreciate,
hurting their exporters and perhaps inducing deflation, which
they already struggle against. Their governments might respond
by raising tariffs on China, a disastrous outcome for Beijing.Buried Treasuries
China could use a bit of depreciation to offset American tariffs. In-
vestors know this, and may be selling yuan now to avoid future
losses. China’s recent Treasury sales probably represent an effort
to keep the depreciation orderly, using dollars to buy yuan from
bearish investors, rather than the start of a belligerent bond dump.
If the pace remains slow, then China could offload more of its
American bonds without angering other trading partners—but
also without causing America much discomfort, if any. Moreover,
as market forces push the yuan down, the value to China of dollar
assets is obvious. They provide China with a bit more macro-
economic autonomy in a global economy dominated by the dollar.
America’s place at the centre of global finance is unassailable in
the short term. Yet neither America nor China appears to under-
stand just why its position is so commanding. China might like to
discomfit America by becoming a credible alternative hegemon: if
investors could flee American assets in response to bad behaviour,
America might behave better. But challenging America would re-
quire open markets, transparent financial institutions and the
rule of law—all of which is difficult for an authoritarian regime.
America seems just as clueless. A protectionist bully is an un-
appealing steward of the world economy. In abusing its privilege,
it undermines the shared trust that makes Treasuries an asset
without equal. This trade war has been built on mistaking
strengths for weaknesses—and weaknesses for strengths. 7Free exchange The bonds that tie
China cannot easily weaponise its holdings of American government debt