If its trade with U.S. ends, China might not need to support dollar with Treasury purchases anymore


Could China Dump Its U.S. Treasuries to Fight the Trade War? A Contrarian View is Emerging in Beijing

By Karen Yeung
South China Morning Post, Hong Kong
Thursday, May 23, 2019

As American pundits and polls dismiss the idea that China would dump its massive holdings of US Treasury debt as retaliation against US tariffs, a contrarian view is emerging in Beijing that the government may use the securities as a “weapon of last resort."

China's US$1.12 trillion holdings account for just 5 per cent of total US national debt, which may mean any material damage on the US economy stemming from a bond sales would be limited. In addition, even if it did cause market volatility, China’s remaining holdings would also be hurt, which the Chinese may view as a move that is too risky, US skeptics have said.

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"While we think China will continue to sell Treasuries, as it has for most of the last year, we do not think that the pace at which they sell will increase as a direct response measure for tariffs. Rather, we believe that the pace at which they sell Treasuries will continue to track the pace at which they see capital inflows," said Matthew Hornbach, an analyst at Morgan Stanley.

However, with Beijing vowing to fight "to the end" and the U.S. preparing to place a 25-percent tariff on a further $300 billion of Chinese imports, China may have "no choice but to sell" its U.S. Treasury holdings, according to some analysts and reports widely distributed on China's social media.

This would devalue U.S. bonds, causing yields to rise, potentially sharply. If China converted the dollar proceeds from its sale back into yuan, it would strengthen the Chinese currency against the U.S. dollar, potentially significantly.

However, one line of thinking is that because the trade war could remove the U.S. as a viable market for Chinese exports, a strengthening yuan against the dollar -- which would make Chinese goods more expensive for American buyers -- may be seen as an acceptable outcome by Chinese policymakers.

"This will happen only when China has no other option. It is a weapon of last resort," said David Chin, the founder of Basis Point Consulting. "If China is not exporting to the U.S. any more, then they do not need to have a weak yuan and strong dollar to encourage Americans to buy." ...

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