The Chinese are threatening to dump US Treasuries even as the federal government borrows money at a torrid rate.

If the Chinese were to follow through, it could wreak havoc on the bond market and send interest rates surging despite the Federal Reserve’s best efforts to hold them down.

The fiscal 2020 US budget deficit surged past $3 trillion in August. And Congress is considering more spending. Treasury Secretary Steve Mnuchin recently  called for more fiscal stimulus and said  “now is not the time to worry about shrinking the deficit.”

Meanwhile, the Chinese have slowly been divesting themselves of US Treasuries over the last several years. At the peak, China held about 1.32 trillion in US debt. That has fallen to about $1.07 trillion as of the last Treasury International Capital data report. Between June 2019 and June 2020, the Chinese divested themselves of  $38 billion in US debt.

Even with the recent selloff, the Chinese still ranks as the second biggest holder of US debt, only behind Japan.

But according to a recent article published by the Global Times, China could further reduce its holding to around $800 billion as America’s “federal deficit increases default risks and the Trump administration continues its blistering attack on China.”

The Global Times is owned by the People’s Daily, an official publication of the Chinese Communist Party.

According to the Times report, “One reason for the bond selling is because Beijing is increasingly concerned about the potential risks behind surging debt level in the US.”

A professor at the Shanghai University of Finance and Economics told the Global Times that the Chinese government could dump even more US Treasuries in an extreme situation.

“China will gradually decrease its holdings of US debt to about $800 billion under normal circumstances. But of course, China might sell all of its US bonds in an extreme case, like a military conflict.”

An analyst at the Everbright Bank told the Global Times that while there has never been a real threat of the US defaulting on its debt in the past, many fear an increasing risk of US default in the longterm.

“Not defaulting before does not mean it won’t default in the future, and risks are accumulating with the ballooning debts and the slumping economic outlook in the US.”

A rapid selloff of US debt by the Chinese would upend global financial markets and send bond rates upward. This would be a nightmare for a US government already trying to sell trillions in Treasuries to cover its massive budget shortfall. But even a slow Treasury dump by the Chinese could be problematic. It would mean a greater supply of Treasuries on the open market even as the US Treasury Department tries to issue new bonds. There is only so much demand for US Treasuries. If the Chinese aren’t buying, and are in fact selling, who is going to buy all of this debt?

Supply and demand dynamics would push bond prices lower and interest rates up. In order to hold interest rates down, the Federal Reserve would almost certainly have to take up the slack. This would mean even more quantitative easing, more money printing and more inflation.

Most analysts think Chinese threats to dump US Treasuries are nothing but bluster. While a major dump of US Treasurys would wreak havoc on the US economy, it would also create problems for China. A fire sale on Treasurys would cut into Chinese reserves and potentially destabilize the yuan.

Then again China wouldn’t have to sell everything to have a huge impact on US interest rates. Even dumping a relatively small percentage of its holdings over a longer period of time would push rates up without more Fed intervention, and the debt-fueled US economy has very little tolerance for higher interest rates. On the other hand, there isn’t much tolerance for more inflation either.



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