24/7 Wall St.

The belief has become widespread that trade wars, particularly deep and long-lasting ones, result in no winners. The United States and China are now involved in the beginnings of a trade war, and how nasty this can get remains to be seen. President Donald Trump believes that the time to act has come and gone and that the United States needs to finally stand up to China (and other nations) after years or decades of giving them a free lunch.

China has retaliated against the United States for increasing tariffs to 25% from 10% on $200 billion worth of goods coming into the United States from China. 24/7 Wall St. recently showed the math behind the numbers, and it seems undeniable that China has far more to lose than the United States in a full-blown trade war that carries on for a long period.

One big issue that has been of concern is what China may do with its vast holdings of U.S. Treasury debt. China has lightened up, even ahead of the end of trade talks, but it may have much more to lose than the United States in its efforts.

It is important to consider that tariffs are only one part of a trade war. One stance that the U.S. president and many U.S. companies have dug in about is the stealing and forced transfer of intellectual property for outside nations that want to have access to China. This is far beyond “knock-off” purses, watches, clothing and so on. This covers issues wherein China did not invent technology but suddenly becomes a big player globally by being able to replicate or just use the intellectual property in technology that it can then sell on the cheap when all consumers care about is price.

An ongoing fear that economists have warned about for years is that China could wake up one day and decide to dump its vast holdings of U.S. Treasury notes and bonds. This would send yields higher in theory, if it occurs, but more importantly it would imply that every Treasury auction in the future for billions of dollars of bills, notes and bonds would not have China as one of the buyers.

Common sense would dictate that China could threaten to sell its Treasuries, but China may simply have no choice at all to hold Treasuries because the nation has to keep reserve assets in some form or fashion. If China wants its currency to remain more stable for its largest export market (that’s the United States, by the way), it is not even remotely close to being in China’s own interest to unilaterally dump dollar-denominated assets.

It turns out that China has been selling U.S. Treasury debt over time. The Treasury’s latest TIC data showed that the nation’s holdings of U.S. government securities fell in March for the first time since last November. Data released by the Treasury late on Wednesday showed that China reduced its Treasury holdings by $10.4 billion (or by 0.9%) in March.

China’s holdings of U.S. Treasury securities had remained steady while it had negotiated during trade talks. If the nation was making a major effort to unload U.S. Treasuries, then that might not be seen until data are released for May or even June, and that won’t be known until later in the summer.

Some reports indicate that China’s reserve managers have considered selling off U.S. Treasury debt. The reason most investors don’t expect it is that China may have nowhere else to go. Yields in Japan and Europe are negligible, and foreign reserves probably will not be considered all that stable, if China just decided to go take a basket of securities (and currencies) issued by less-than-major economies.

China held $1.12 trillion in Treasury securities, making it the largest foreign holder of Treasury debt, and Japan is second with $1.078 trillion. The difference here is that Japan has increased its Treasury holdings while China slowly has lightened up.

According to the U.S. Treasury, the total balance of foreign-owned Treasury debt was $6.4733 trillion at the end of March 2019. That is actually up from the $6.2234 trillion in March of 2018.

If you visit the historic tables of the so-called TIC-data, China has been shown to be a larger holder of debt and a smaller holder of U.S. Treasury debt over time. It has held more than $1.3 trillion as recently as 2013, and it was shown to have held under $900 billion as recently as 2010. In the pre-recession years of 2004 to 2007, China had average Treasury securities holdings of between $600 billion and $700 billion.

Now, it is important to consider how much total U.S. Treasury debt is actually outstanding. The figure for the May 14, 2019, total debt showed a balance of almost $16.2 trillion in direct debt held by the public and an additional $5.85 trillion in intragovernmental debt. After backing out the rounding of numbers, that’s now a total of $22.027 trillion in total public debt outstanding.

China may choose to hurt itself by dumping U.S. Treasuries to prove a point, but China’s Treasury holdings currently account for about only 5.1% of the total public debt outstanding. Just as China has more to lose than the United States in a trade war, it has more to potentially lose than the United States if it decides to dump its U.S. Treasury holdings entirely.