The spectre of China selling USTs has risen again as trade tensions between the US and China
heighten. The basic assumption is that US rates will go sky-high and the USD would plummet.
However, there are several reasons to think the net effect would not be so dramatic. Firstly – and
most simply – the initial flight-to-quality would support bond prices. Secondly, China owns a
declining proportion of outstanding USTs, falling from 11% in 2010 to under 7% today (top chart).
Thirdly, China still has a large trade surplus it needs to recycle (bottom-left chart). If China sells
US bonds it still needs to reinvest the proceeds. There are several things it could do, but all are
likely to lead to a less extreme move in US interest rates and the dollar than might be expected.
If China starts to diversify away from USTs, it would still have to buy something instead. Europe
and Japan would be the most likely be destinations for Chinese capital, but these are far from
optimum from a yield standpoint (last chart). But there is a more subtle point, and we’ll choose
a simple case to illustrate it. Wherever China sends its capital, all other things equal, means
a lower trade balance in that country, and with it lower growth and higher unemployment. A
natural response from the country would be to buy US debt with the imported Chinese capital,
re-weakening their currency, keeping a lid on interest rates and the USD supported. No country is
likely (or able) to accept the huge adjustment forced onto it by China selling her Treasuries.
(Click on image to enlarge)