Why China Isn’t Dumping U.S. Treasuries: A Strategic Calculation
As an observer of one of the most significant financial confrontations of this decade, I’ve often questioned why China has not simply liquidated its substantial holdings of U.S. Treasury bonds. After all, it is no secret that such a move would severely destabilize the U.S. dollar, cause a sharp rise in American interest rates (Trump’s worst nightmare), and overall further disrupt an already turbulent U.S. economy.
Naturally, I can’t help but picture this economic standoff as a modern-day Cold War, with China’s “nuclear option” being the mass dumping of its U.S. debt holdings. So why hasn’t China done this yet, despite the potential to significantly undermine its economic rival?
First of all, it is important to highlight that China HAS been reducing its dependence on the U.S. dollar. According to the State Administration of Foreign Exchange (SAFE), dollar-denominated assets accounted for 55% of China’s official currency reserves at the end of 2019, down from 79% in 2005. However, it is important to note the role of state-owned commercial banks, which appear to maintain a strong preference for the U.S. dollar, continuing to accumulate dollar-denominated assets. This behavior offsets, to some extent, the central bank’s efforts to diversify away from the dollar.
Moreover, China’s holdings of U.S. Treasuries have also been declining. As of February, they stood at $784 billion, according to U.S. Treasury data, down from a peak of $1.32 trillion in 2013. Recently, there has been speculation that the bond market’s volatility is due to China “dumping” its Treasuries. However, no official data from the Chinese government supports this claim, making it purely speculative. It’s worth recalling the 2018–2019 trade war: although China responded by allowing the yuan to depreciate, at no point did it resort to large-scale selling of U.S. Treasuries.
But let’s return to the data itself, which can be somewhat misleading. While it is true that China’s direct U.S. Treasury holdings have declined, the holdings reported under Belgium and Luxembourg have suspiciously increased. This is likely because China uses international custodial services such as Euroclear in Belgium and Clearstream in Luxembourg to hold Treasuries. When adjusting for this, it appears that China may have sold far fewer Treasuries than the headline figures and media narratives suggest.
But, back to the main question, why aren’t they considerably selling their Treasuries stash, though? Because yes, there is no doubt that their holdings have been decreasing, but I feel like that’s more of a strategy to simply reduce their exposure to the dollar overall (Treasuries being a quite prevalent dollar-denominated asset). The answer is not that they can’t, but that doing so would simply not be in their own interest. As your econ insider, I must remind all of you that selling their Treasuries would crush the value of their own holdings (= heavy losses), because gradually, as they sold them, it would inevitably depress the prices of their current holdings. Dumping their bonds would hurt them just as much as it would hurt their opponent.
But let’s say they did want to weaponize the dollar: they would inevitably start by selling Treasuries but buying other U.S. assets. This would have no major consequences for either country, but it would be a way to reduce their exposure to U.S. government debt. Then, they could discreetly start moving towards European assets, for example, but that is not desired by those economies, because it would strengthen the euro and put them at a disadvantage in trade (exports would be hurt). They could also try emerging markets, but that would be too risky.
To conclude, I believe it’s important to simply sum up by emphasizing once again that the U.S. Treasury market is the largest in the world, meaning that disrupting it would only put the entire international stage at a disadvantage.