China cannot easily weaponise its holdings of American government debt

Market Overview June 06, 2019 (0)

Neither country seems fully to understand the ties that bind them

AN 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 counterpart, 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 America 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, eager to follow the time-tested path to export-led development, favoured an undervalued currency. In the early 2000s, as rapid growth in output and exports put upward pressure on the exchange 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 holdings 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.