By Richard Leong
(Reuters) – The trade war between Beijing and Washington has worried concern in financial markets that China may choose to weaponize its holdings worth more than $ 1.1 trillion worth of US Treasuries in return for the tariffs imposed by the Trump administration on Chinese imports.
Often referred to as "core choice," and choosing to dump such a pool of assets will likely destabilize the world's financial markets, drive interest rates higher and push tensions between the world's two largest economies into unknown territory.
China has slipped its government bond portfolio for some time, but most analysts see an aggressive reduction in their holdings as an external opportunity at most. There is no evidence Beijing looks seriously into flooding markets with its US bonds.
Here are some key points about China's Treasuries portfolio:
How big US debt does China?
A decade ago, China took over Japan as the largest foreign holder of US government debt.
Its holdings stood at more than $ 1[ads1].12 trillion at the end of March, according to US Treasury departmental data. Japan is a close second with almost $ 1.08 trillion.
China's holdings peaked at nearly $ 1.32 trillion at the end of 2013 and have come down by about 15% since then. In March, they were the lowest for about two years.
Part of the Treasury has fallen even faster due to the steady issuance of US debt needed to fund the growing federal budget deficit.
The world's second largest economy owns about 7% of the $ 16.18 trillion of outstanding public debt US debt, the lowest 14-year and down from a 14% peak in 2011. Nevertheless, the only part of the cake is exceeded by the US Federal Reserve, which owns $ 2.15 trillion of Treasuries, or 13.5% of the market.
Treasury issuance is expected to continue accelerating after a massive tax cut adopted in December 2017, so China's share of the market is likely to fall even further.
(GRAPHICS: China, Japan Holdings of US Treasuries – http: // tmsnrt.rs/2DJ1ckW)
WHY CAN CHINA OWN SO MUCH US DEBT?
As a net exporter to the United States and the rest of the world, China has the world's largest foreign exchange reserve of more than $ 3 trillion. Much of it is denominated in US dollars accumulated through the continuing trade surplus with the United States since the early 1990s.
A natural place for China to park many of these greenbacks is the US Treasury market, which is by far the largest and most liquid pool of secure assets in the world.
Since the financial crisis in 2007-2009, US government bonds have consistently provided more than bonds issued by other major developed economies such as Japan and Germany, which have been another lure.
(GRAPHIC: China's share in the US Treasuries vs yuan – https: // tmsnrtrsrs / 2HziSTz)
WHAT IS THE RISK TO THE UNITED STATES ABOUT CHINA SELLING?
Most analysts agree that large-scale sales of Beijing will interfere with the Treasury and other markets.
An abrupt change in the balance between supply and demand can lead to lower government bonds and increase yields, which are moving in opposition to prices. This will lead to an increase in borrowing costs for the US government.
Also, because tax returns are a reference point for US consumer and business loans, interest rates on everything from corporate bonds to residential real estate will increase, which is likely to slow down the economy.
Such a striking feature will also destroy global investors' confidence in US dollars as the world's best reserve currency.
(GRAFISK: Currency composition of foreign exchange reserves – https://tmsnrt.rs/2V2VgLt)
HOW IS THE RISK OF CHINA ABOUT THE DUMPER TREASURIER?
Most analysts claim that China has not chosen to sell Uncle Sam's IOUs because a nosedive in US bond prices will also reduce the value of China's remaining treasury.
China's currency, the yuan, is not fully free floating. Beijing uses its government bonds as a key tool to stabilize the yuan within a targeted range, especially against the dollar.
Some critics have argued that China is using treasuries and its other currency reserves to hold down the yuan and make exports more attractive. At the same time, so that the currency can become cheaper, other problems, such as foreign capital flight, run the risk.
Any heavy write-down in the greenback can force Beijing to defend the yuan, which could mean throwing more of the Treasuries stock. Back in 2016, China's treasury attitudes fell sharply by around $ 200 billion from May to November of the year when the yuan depreciated the concern for the Chinese economy.
Finally, any banking impact in the US economy will also be felt in China because the US is the target of almost one fifth of Chinese exports.
(GRAPHICS: China-US trade: monthly figures – https://tmsnrt.rs/2Lzed8e)