It is often called the nuclear option.
In the trade war between the United States and China, economists and investors have long tried to game out how both sides might use their clout. In virtually all the predictions, at least until recently, they revolved around a tit-for-tat tariff war.
Even in the gloomiest of doomsday scenarios, there is one weapon that has long been considered unthinkable: the Chinese, the biggest holder of United States foreign debt with more than $1 trillion, publicly taking a step back from buying United States Treasuries — or worse, dumping what they own in the open market.
The very idea is typically dismissed as a waste of time to even consider, and the reason is a sort of mutually assured destruction. It would be wildly irrational in economic terms, the thinking goes. China selling Treasuries would send interest rates up and hurt the United States, but it would simultaneously severely damage the value of China’s own Treasury holdings. As the industrialist J. Paul Getty famously said, “If you owe the bank $100, that’s your problem; if you owe the bank $100 million, that’s the bank’s problem.” In the United States-China relationship, China is very clearly the bank.
But the conventional wisdom about what China might — or might not — be prepared to do could be wrong. China has lately reduced its holdings of United States government debt, and a growing number of financiers, economists and geopolitical analysts are quietly raising the prospect that China may look to its ability to influence interest rates as its ultimate Trump card.
If China were to undertake such a maneuver, it would do so at a delicate time for the United States economy: The rising deficit has increased the Treasury’s borrowing needs. There is more debt to be purchased, and the Federal Reserve is raising interest rates, making that debt more expensive. It’s not clear how much China could drive up rates by shedding Treasuries, but it would certainly add to the momentum already present.
And it is worth remembering that Beijing’s endgame is not necessarily to ensure the financial health of its country this year or the next. If China were to suffer short-term pain to gain a real and lasting advantage over the United States — or at least not lose any advantages it does have — it might be willing to struggle a bit today.
“The negotiation between the two great powers isn’t about how many soybeans or Boeing airplanes they buy by the end of the year,” said Kevin Warsh, a former governor of the Federal Reserve. “We are at a pivotal moment in history. The actions of the U.S. and Chinese governments in the next 12 months will set the course for the relationship of the two great powers of the 21st century.”
And the war of words is only getting sharper. Last week, Vice President Mike Pence accused China of using “political, economic and military tools, as well as propaganda, to advance its influence and benefit its interests in the United States.” And on Monday, China’s foreign minister, Wang Yi, admonished the Trump administration for “ceaselessly elevating” trade tensions and “casting a shadow” over relations between the two countries as he sat directly across from Secretary of State Mike Pompeo.
Still, critics who dismiss the possibility of China trying to upend the United States Treasury market say that China’s own economy is too fragile to risk doing anything that would cause instability.
Stability has long been a watchword in China. Over the weekend, China’s central bank, clearly nervous about a slowdown, pumped $175 billion into the economy by lowering the amount of money that some lenders are required to hold in reserve, allowing that money to circulate freely instead.
Supporters of the Trump administration’s tough stance on tariffs with China take actions like that as a sign that the United States holds the negotiating leverage. And it remains an open question whether China could inflict real damage by selling Treasuries.
“Treasuries sales in a sense are easy to counter, as the Fed is very comfortable buying and selling Treasuries for its own account,” wrote Brad W. Setser, a senior fellow for international economics at the Council on Foreign Relations. “I have often said that the U.S. ultimately holds the high cards here: The Fed is the one actor in the world that can buy more than China can ever sell.”
Even so, the market dynamics are unpredictable. Chances are, over the past two decades, there have been Treasury auctions at which the Chinese haven’t been bidders. But whether they were active bidders or not, the other bidders have always had to assume they were.
It is one thing to show up at Sotheby’s and not raise your paddle. It would be quite another to send out a news release saying you’re never going to Sotheby’s again.
The problem is that China would have to find something to do with that money — and, in this case, the auction house is always offering the best deals in town.
“Even if it could sell its more than a trillion dollars of Treasurys without pushing the market against it, where would it park the funds?” Marc Chandler, global head of currency strategy for Brown Brothers Harriman, wrote in a note to investors. “It will not be able to secure the liquidity, safety and returns that are available in the U.S.”
But brinkmanship does not breed rational thought. The escalation of hostilities, even economic ones, raises both stakes and tempers alike, which is a dangerous combination.
And in this case, there is no proving ground. There is no predictable math, no scale model.
If China were to use its nuclear option and the markets didn’t react, it would lose influence in stark fashion. If it worked — but was more effective than expected — China could inflict unintended damage on its own economy.
And even a perfectly executed strike that left China unharmed would be perilous: A targeted attack on the United States economy would have unknowable repercussions. If the fallout cloud settled over Europe or emerging markets, would China be ready for that fight, too?
Since the end of the Cold War and the proliferation of nuclear weapons, the world has embraced a policy of strategic stability: reducing the incentive for rival nations to unleash unimaginable destruction.
That is probably good economic policy, too.
