With the United States and China trade war becoming more fierce, the stock market tanked and the bond market rallied on news that China devalued its currency and is blocking U.S. agriculture imports. This was retaliation against President Trump’s latest round of tariffs announced last week. With escalation comes speculation on what will happen next.

While the latest fallout after the trade war salvos seems to have priced in close to half of an additional interest rate cut from the U.S. Federal Reserve, it’s time to wonder what will happen if China does what used to be considered unthinkable: selling off its massive holdings of U.S. Treasuries.

China is the largest holder of U.S. Treasury debt, at more than $1.11 trillion. As of August 1, 2019, the Treasury listed a total of all public debt outstanding as $22.02 trillion. That consisted of $16.246 trillion in direct debt held by the public and $5.776 trillion in intragovernmental holdings.

It might have been considered the end of the world if China would have sold off its massive U.S. Treasury holdings a decade ago. In 2019, the initial fallout may be more muted in the initial reaction.

Back in 2010, China moved to over $1 trillion in U.S. Treasury holdings. It had more than doubled its Treasury holdings since just in early 2008. The total public debt outstanding as of January 1, 2009, was $10.6 trillion, and that rose to $12.29 trillion on January 1, 2010, and $15.22 trillion in the first day of January 2012.

Here are some basic figures for looking into how much damage China could cause in the U.S. Treasury market. The $1.11 trillion of Treasuries held by China is about 27% of the Treasury’s bills, notes and bonds held by all foreign countries (May 2019). The rest of that $22 trillion in Treasury bills, notes and bonds is held by Americans, investment firms and even by the government itself.

China has the greatest amount of U.S. debt held by a foreign country. Japan was a close second with $1.101 trillion in May. Japan is currently more closely aligned with the United States than it is with China, but with the unrest in Hong Kong and China’s massive weight it carries there it has to be at least up for grabs if Hong Kong would risk selling its Treasuries too.

With Mainland China holding $1.11 trillion in Treasury debt and Japan holding $1.101 trillion as of May 2019, the next largest holders of U.S. Treasury debt were very far behind:

• The United Kingdom, $323.1 billion
• Brazil, $305.7 billion
• Ireland, $270.7 billion
• Switzerland, $231.4 billion
• Luxembourg, $229.6 billion
• The Cayman Islands, $216.1 billion
• Hong Kong, $204.0 billion
• Belgium, $190.5 billion
• Saudi Arabia, $179.0 billion
• Taiwan, $172.0 billion
• India, $156.9 billion
• Singapore, $150.4 billion
• France, $125.1 billion
• Korea, $117.3 billion
• Canada, $100.5 billion
• Norway, $99.3 billion

It remains to be seen what China might do if it were to theoretically sell off its Treasury securities. The drop in reserve assets likely would hurt the nation’s credit ratings, and those reserve assets would have to go somewhere. It’s almost impossible to think that China could just buy gold or move into a basket of euros, yen and other national currencies.

It’s important to think “down-range” about actions and reactions. The probable outcome initially for China to dump its Treasury debt would be minimal. It likely would create a temporary blip higher in interest rates, and the Federal Reserve and interest rate watchers might even welcome that. The problem is what happens in future debt auctions if China (and maybe other nations) decided to not buy U.S. Treasury debt. That would create less ongoing demand for Treasury debt and higher and higher interest rates. Then imagine when the next international crisis comes about and that $22 trillion in total outstanding Treasuries grows rapidly.

All this said, and even including if China took it on the chin in the financial markets and saw a further drop to its currency, President Xi Jinping does not have to answer to an electorate every four years like President Trump. Xi also can pass on a lot more economic misery to his own population for years and years if he and those in charge of China decide to take that route.

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