China can’t dump US debt

Via FTAlphaville:

The pace at which China is selling its holdings of US Treasuries has accelerated dramatically since the beginning of 2018.

Against the backdrop of the escalating US-China trade war and other protectionist measures, the move has sparked concerns that China is actively weaponising its position as the largest foreign creditor to the US government. The fear is that such selling — especially at a time when foreign demand for US Treasuries has flatlined — will result in higher US interest rates, pushing up borrowing costs.

China is unlikely to use its $1tn plus of US Treasuries as a trade war weapon, however, because it would be financially destructive to both sides with China, ironically, bearing most of the burden. Indeed what’s also holding China back from diverting its massive, albeit declining, stock of savings is the simple fact that there is no market as deep, liquid and safe as that of US Treasuries.

First let’s examine the issue of demand. While China is on pace to run a small current account deficit this year after decades of posting a sizeable current account surplus, its appetite for foreign assets remains elevated. What’s more, at 42 per cent, foreign exchange reserves comprise the predominant share of these assets, as Shweta Singh at TS Lombard points out in a recent note:

Clearly, China’s need for a place to park its savings isn’t going away any time soon, even if the country’s external position is getting smaller. It is on this supply point that China runs in to trouble. No market can compete with the US Treasury market when it comes to size and stability.

As Singh shows in the chart below, the amount of outstanding US public debt securities is nearly double that of the next largest market, the Euro area, as well as the third largest, Japan. To boot, it is over three times the size of China’s, which sits in fourth place at roughly $5tn:

In terms of stability, there is also little competition. Per Singh, the number of AAA-rated sovereigns across the euro area has declined since the financial crisis to the extent that safe-rated debt amounts to just 10 per cent — or $2tn — of Euro area’s GDP. Over the same period, the amount of sovereign debt with this high credit rating has surged in the US. It now totals $18tn, or more than 70 per cent of its GDP:

And then there’s the fact that the US dollar is the most widely used currency in the world from an invoicing, financing and reserves basis which means it remains the destination of choice for not only China, but the majority of economies as well. Despite efforts from both Europe and China, the dollar’s dominance has yet to be seriously challenged.

So until that changes, and a viable alternative to the US Treasury market takes shape, China has little choice but to stick to more traditional trade war weapons.

David Llewellyn-Smith

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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