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China’s nuclear option of dumping US debt would backfire

Investors have worried about how China will retaliate against US tariffs once it runs out of badets to impose taxes. China has many levers to pull, including allowing its currency to sink, blocking the export of rare earth minerals or even organizing boycotts of iPhones and other US products.

The outbreak of tensions in recent weeks has also led to speculation that China could cut its holdings of US debt. State media in China, the largest holder of US Treasury bonds, amplified that speculation.

The highly followed Twitter account of Hu Xijin, editor-in-chief of China's Global Times, said earlier this month that "many" Chinese academics are discussing the "possibility of getting rid of US Treasury bonds."

However, it is unlikely that Beijing will put its vast reserves of US debt in arms, since such a dramatic step would probably be counterproductive, perhaps wrong. It would deplete China's own financial resources, reduce confidence in the country as a responsible actor and scare global markets. And it's not even clear that the fact that Treasuries jump even would have the desired impact of harming the United States.

"China is not going to do that, it's a meaningless exercise," said Barry Bannister, head of institutional equity strategy at Stifel.

Such sale to the fire would be destined to damage the value of the bonds of the Treasure of the EE. UU., Which would cause an increase in yields. That would be a big problem because the 10-year Treasury rate serves as a reference point for other forms of credit. The costs of loans for everything from car loans and mortgages to commercial debts will increase.

"It's more possible now than at any time in recent history," said Guy LeBas, chief fixed-income strategist at Janney Capital Management.

How could it be counterproductive

However, badysts do not believe that China would actually shed the Treasury bonds in part because it would be equivalent to shooting itself in the foot. A fire sale would cause your own holdings to lose value.

LeBas called it the "take your nose" strategy.

"The last thing they want is to damage the value of their remaining holdings," said Michael Hirson, former chief representative of the US Treasury Department in China.

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Hirson, currently China's chief practice in the Eurasia Group, said it would reduce the amount of foreign reserves that Beijing has at its disposal to defend its currency and maintain financial stability.

China also has limited alternatives for what to do with all its excess cash.

Re-deploying the money in Japanese and German debt is not ideal. The 10-year bonds of both nations are showing negative results at this time, compared to the declining, but still positive, 2.2% yield for US Treasury bonds. The 10-year German bond rate fell to a record low on Friday.

And holding cash would risk allowing China's own currency to become too strong, which tends to be deflationary.

"If China goes down, they will have more loan problems in their banks, that's the last thing they need," Bannister said.

Another problem with China's Treasury bonds is that it risks destabilizing the global financial markets at a time when they are already nervous. The financial crisis could spread to the real economy, worsening the slowdown in growth underway in China's trading partners.

"If you are waging a trade war with the United States, you want a stable economic environment for the rest of your exports," said Hirson.

Would it even work?

It is not even clear that China can create a panic in the US Treasury market.

China sold 600 billion dollars of US Treasury bonds. UU Between mid-2014 and the end of 2016, however, yields fell, according to Stifel & # 39; s Bannister.

The debt of EE. UU It is considered one of the safest badets on the planet. There is ample demand, especially during the recent market crisis, from other foreign buyers, large life insurance companies, pension funds and large banks.

That demand would only increase if China frightened investors by getting rid of US Treasury bonds. During times of fear, cash tends to flood US debt.

"It seems that there is a ready market in a world destabilized for US Treasury bonds in a sense of flight to safety," said Bannister.

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And a modest increase in Treasury yields in the United States could be temporary. Higher yields would probably only attract buyers to return, which would push rates down.

"China, by getting rid of the Treasury bonds, could scare the world markets without harming the United States," said Hirson. "But it would harm China's reputation as a source of stability and responsibility."

Instead of getting rid of Treasuries, badysts said China would seek retaliation in other ways.

For example, there is growing speculation that Beijing will mandate restrictions on the export of rare earth minerals that are crucial to the technology and defense industries. And on Friday, China's Ministry of Commerce announced plans to compile a blacklist of foreign companies that violate market rules, a likely response to the ban on US exports to Huawei.

"If the goal is to hurt US financial markets," LeBas said, "selling Treasuries is not the way to do it."

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