Two years ago, I explained how the BRICS countries—a growing group of non-Western economies led by Brazil, Russia, India, China, and South Africa—could do serious harm to the U.S. dollar if they shifted a large enough share of their trade and central-bank reserves to other currencies than the dollar.
In a parallel move, the BRICS governments could also sell their holdings of U.S. Treasury securities. As the Federal Reserve scrambles to buy up that debt, it ends up in a battle against time and the tidal waves of a coordinated, global flight from the dollar.
This is a nightmarish scenario that—I would like to point out—we are nowhere close to. But we just got a glimpse of how it could be set in motion. Given what is at stake here, it was not at all surprising to see news stories that conveyed both drama and anxious anticipation of what could come next.
Take as one example Vinod Dsouza with Watcher Guru:
China and other BRICS countries have been offloading US treasuries worth billions since 2022. … The development indicates that BRICS and other developing countries want to move away from owning US assets in their reserves.
Dsouza, who does not seem to be good with numbers, editorializes that the “uncontrolled” U.S. government debt is “making BRICS rely on local currencies” instead of the dollar. He then quotes a Bloomberg “strategist” who blames Trump for wanting to start a trade war. There is no mention of the fact that President Biden just announced new trade tariffs on select Chinese products.
In a related article, Dsouza tries to drum up the same story angle with misplaced references to the International Monetary Fund.
As a counter-balance, behold a less protruding approach by Yahoo Finance. Republishing a story from Bloomberg, they point out that the Chinese sell-off had less to do with fears of Trump starting a trade war with China that Biden is already waging, and more to do with the Chinese government having a need for portfolio diversification.
Let me make clear that although Dsouza’s writing is melodramatic in nature, there is a grain of truth in it. The same can be said about the angle taken by Yahoo Finance and Bloomberg. It is very much true that the Chinese government could use its sizable holdings of U.S. debt as an instrument of economic warfare, but that does not mean that they just did that. In fact, if we want to properly understand what is behind the Chinese sale, we need to know something about the volume of their sale relative to the market for U.S. debt.
We might also want to inquire if there are any domestic policy issues in China that could play in here.
In terms of debt volume, the Chinese sale of $53.3 billion was unusually large for being a sale from them, but it gets less impressive when compared to the total volume of the market for U.S. debt. For comparison, on May 14th, the U.S. Treasury auctioned off $50.6 billion in debt with a one-year maturity. That is just one auction under one of the 13 maturity classes in which it sells debt. In the week of May 13th-17th, the Treasury auctioned off a total of $425 billion in new debt. Some of it matures in a matter of weeks, some of it a year from now; the point is that the volume of debt being traded in the primary debt market is so vast that even a sell-off like the one China just did is unlikely to have anything more than a marginal effect on the market.
The Chinese sale shrinks even further if we take a look at the trade volumes on the secondary market for U.S. debt. This is the market where those who already own Treasury securities can sell them, and those who did not get in on the auctions can buy them. According to SIFMA Research, citing data from the Federal Reserve Bank of New York, the average daily trade volume in U.S. debt exceeded $900 billion in April. This means that if the Chinese debt sale took place in just one day, it did not even equal 6% of the average daily volume.
As it happens, the $53.3 billion was their total sale of U.S. debt throughout the first quarter of this year. To make a long story short, in terms of quantity, the Chinese government’s debt sale did not even make a dent in the debt market, let alone the dollar.
With that said, if China wanted to destabilize the market for U.S. debt, it certainly could do so. According to the most recent data on who owns the U.S. debt, the Chinese government held $797.7 billion. While this is substantially less than the $1,124.3 billion they owned back in 2018, it is still a sizable volume.
A fair question to ask here would be what gains there would be for the government in Beijing if they put all that almost $800 billion in U.S. debt up for sale at once. But before we even try to crunch the numbers, it is worth noting that this type of mad debt dumping will not happen this side of a cataclysmic economic event. No sane manager of a government’s asset portfolio would sell such major volumes in such short order. It would guarantee that the government would take major losses on those assets—which of course raises the question of what the motive would be in the first place.
However, just to complete that thread of thought: if China did sell all its U.S. debt in one day, metaphorically or literally, the U.S. economy would suffer a major shock. It would be a temporary one, but it would be a tough punch. The question is what the Chinese government would do when its own massive sell-off crashed the value of that asset. Could they stand to lose 80-90% of the value of those U.S. debt securities?
It is more realistic to imagine a strategic Chinese debt sale as a trickle. If they really wanted to use their holdings of U.S. debt as an instrument of economic conflict, they would make frequent sales that were small enough to avoid any significant value losses on their end, yet big enough to prevent the Federal Reserve from cutting its interest rate. By forcing the Fed to keep its federal funds rate elevated, and by forcing Treasury yields to stay high, the Chinese could help nudge the U.S. economy into a recession.
I fail to see what China would gain from this, other than undermining efforts by Congress to increase military spending. I would not rule out that China could resort to such an overly complicated tactic to achieve such a goal, but it is also important to keep in mind that we still have not considered that the Chinese government may want to sell U.S. debt for reasons of domestic policy.
In an interesting article for Sina Finance, a Chinese financial news outlet, economist Ren Zeping explains that the Chinese economy is in dire need of fiscal stimulus. The Chinese government sector is losing revenue:
In the first quarter, the national general public budget revenue fell by 2.3%, of which tax revenue fell by 4.9%, value-added tax fell by 7.1%, personal income tax fell by 4.5%, and non-tax revenue increased by 10.1% year-on-year.
This, Zeping explains, is an “abnormal” situation where non-tax revenue is rising while tax revenue is in decline. Although he does not explicitly mention this, local Chinese governments have a history of selling land to get revenue when taxes have not generated enough money. In other words, they are spending one-time revenue on permanent programs.
In plain English: the Chinese government sector suffers from a structural budget deficit. This deficit is a sign of a permanent downshift in economic activity, which in turn makes both government spending and private investments unsustainable over time.
The solution is not some quick-fix measure like a tax hike. As economist Zeping wisely recognizes, the Chinese economy is in bad need of broad-based policy reforms that can both boost the demand side of the economy and enhance the productivity of the supply side. He refers to this as “the ‘new’ economic stimulus and new infrastructure” plan.
Like all fiscal policy programs of this magnitude, Zeping’s “new” stimulus requires funding. Lots and lots of funding. Another writer for Sina Finance, Zhang Ming, adds more details on how the Chinese government plans on solving this problem:
On October 24, 2023, the Chinese government announced the issuance of an additional 1 trillion treasury bonds. All funds raised from the issuance of treasury bonds will be arranged to local governments … The government … [also] stated that it plans to issue ultra-long-term special treasury bonds for several consecutive years starting from this year, specifically for the implementation of major national strategies
Bluntly speaking, these two Chinese writers tell us that the government in Beijing is in dire need of liquidity to stimulate its flagging economy and to avoid a debt disaster among its local governments. Their analyses align well with a May 16th article at China Banking News.
The sale of U.S. Treasury securities makes sense in this context. The sale, which if executed at an average exchange rate of 7.23 yuan to the dollar, would have brought in approximately 385 billion yuan—a small but not insignificant amount compared to the stimulus borrowing that the Chinese government appears to be engaged in right now.
We should never underestimate the dangers of the dumping of U.S. debt by nations that are hostile to, or feel mistreated by, the U.S. government. So far, we have not seen any real signs of any such moves, but that does not mean there won’t be a strategic, broad-scale sale of U.S. government debt in the near future. In fact, I would be surprised if there wasn’t such an attempt at some point in the next 12 months.
