Tariffs, counter-tariffs and headlines about trade wars are flowing like wine as the long-anticipated Trump campaign against China is finally shaping up. Given that futures are tumbling, the US trade deficit has just hit a decade low, and, oh yeah, we haven’t seen market volatility like this since the crash of ’87 you might think we have enough ominous financial storm clouds to worry about at the moment. But (if you listen to Reuters) you’d be wrong.
“China, holding Treasuries, keeps ‘nuclear option’ in U.S. trade war” blares their headline from this past Wednesday. Ah yes, the old “nuclear option” canard.
So what’s China’s so-called “nuclear option?” Well, it starts with a chart showing China as the largest foreign holder of US Treasuries.
…and it proceeds with the insinuation that China could dump all of its Treasuries on the market at once, causing (you guessed it!) a total obliteration of the market and a crisis for Uncle Sam and his almighty dollar.
That’s the theory, anyway. But is it really true? Could China really deploy its “nuclear option,” cause a market panic and sink the dollar? Of course not. At least, not in the way the headline writers want you to believe.
In fact, Reuters even admits this a few paragraphs into their own attention-grabbing clickbaity article:
Jeffrey Gundlach, the chief executive of DoubleLine Capital LP, said China can use its Treasury holdings as leverage, but only if they keep holding them.
“It is more effective as a threat. If they sell, they have no threat,” said Gundlach, known as Wall Street’s Bond King.
“It would only escalate the situation and eliminate their leverage.”
Well, I don’t expect that I would agree with the CEO of DoubleLine Capital on many things, but he’s not wrong here. Much like the thousands of nuclear warheads that could destroy the planet many times over, this “nuclear option,” too, is more of a bluff than a card that can be played. The first and foremost victim of a panic in the Treasuries market would be the People’s Bank of China, who would stand to lose USD$1.2 trillion all at once.
Beyond that, it’s an open question in this black-is-white, bad news is good news “new normal” economy whether China dumping its Treasuries would even crash the market. After all, people have worried about China’s declining reserves in the past, but those sales obviously did not curb the world’s appetite for Uncle Sam’s debt.
Besides, remember when it was suddenly “revealed” (read: admitted) that Saudi Arabia had $750 billion in Treasuries as a result of the decades-old petrodollar arrangement that has only recently been acknowledged? And remember when there was then a lot of hand-wringing about whether the Saudis would react to the release of the 28 pages by holding a Treasury fire sale? Well, as I noted at the time, it’s by no means clear that the market (as it stands today) wouldn’t be able to absorb the selling. In fact, at that time (i.e. 2016) the Treasury market had already absorbed China’s 20% reduction in holdings without missing a beat.
Remember, this is all a con game. Literally. A confidence game. As long as people believe in the US dollar, then the dollar is “sound.” As long as people believe that Washington will be able to make good on its debts, then that debt has “value.” So if nothing else changed, it’s conceivable that a sell-off of Treasuries, even a massive dumping, would only be seen as a buying opportunity by others. And, if not, there’s always the Fed to come along and buy the Treasuries directly, right?
To paraphrase George Costanza: It’s not toilet paper if you believe in it.
But with this realization we discover the status quo’s real Achilles heel. It’s not the pull-the-plug-on-the-bathtub “nuclear option” of a Treasury fire sale that keeps Uncle Sam and his henchmen up at night. It’s the idea of filling up another bathtub.
What if, instead of dumping all their reserve holdings and shooting themselves in the economic foot, Beijing was instead building up an alternative global trading system. One built on an infrastructure funded by China with the excess reserves from its vast trade surplus with the US? One involving dozens of other nations in trade agreements based on “win-win” development projects? One where those trading partners increasingly agreed to trade in local currencies and bypass the dollar?
This is the real “nuclear option.” Not the fiery explosion of economic Armageddon, but the slow and painstaking creation of an alternative system (Mandatory caveat: “alternative” system). And if this project comes to fruition, then it won’t even matter if China sells or holds its US Treasuries. They will be irrelevant.
Now obviously we’re still a long way off from that point, and China, for its part, is at least putting on an outward show of rejecting the “nuclear option” strategy. In a briefing this week, the country’s Vice Finance Minister, Zhu Guangyao, told a Wall Street Journal reporter that “China is a responsible investor in the global capital market” and stressed that Beijing is only interested in safeguarding the value of those reserves. And in a meeting with Russian Foreign Minister Sergei Lavrov last Thursday, Chinese State Councilor and Foreign Minister Wang Yi placed the blame for all this chaos squarely on Washington, calling for a joint effort by the world community to protect the global(ist) free trade system.
But this is the type of “let’s all play by the global(ist) rules, gang!” pep talk that plays in Peking a lot better than it plays in Peoria, and at the end of the day, it’s just that: talk. Actions speak louder than words, and no one can deny that China’s actions are toward the creation of a US dollar alternative.
So, in short, I wouldn’t lose any sleep over the thought of a Chinese fire sale of US Treasuries. But the prospect of the slow and inevitable erosion of US hegemony and the inevitable collapse of confidence in the dollar that will follow that? Or the prospect of the US heading that off at the pass with a trade war that escalates into a real war? Well, that might be worth thinking about.