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We have a question asking what would happen if China decided to dump all of its U.S. treasury? There are basically two parts really. The first one is what would happen if they dumped their treasuries? And then based on that, what is the likelihood of that really happening? So to the first part, what would happen if they did?
Now, currently China holds about 7% of U.S. public debt outstanding. But that has drastically decreased considerably from the almost 14% that they held back in 2011. And it is still way less than half of the size of what is owned by the Federal Reserve alone. Now dumping that number of treasuries would definitely create a massive amount of turmoil in financial markets and probably cause widespread panic and uncertainty.
The biggest challenge it would cause to the U.S. itself is that it will cause the borrowing costs, the U.S. borrowing cost to drastically spike higher as the big influx of supply in terms of treasuries or bonds will decrease the bond prices and cause a huge spike or move higher in treasury yields.
Now that is obviously a very big problem for the U.S. economy as the higher the yields go, the higher the overall credit will become like mortgages, credit cards, cars, everything. All credit will start to basically cost more and increase because the U.S. treasury yield is the benchmark for overall credit in the United States.
Now it could also cause, other investors that’s also holding treasuries to dump their treasuries as well. And that’ll obviously cause further drops in the prices and they will start to unload some of their treasury holdings in the fear that the price will start to drop considerably due to that big influx from China. And that of course will cause massive volatility spikes in the fixed income market and cause huge stresses in the financial markets as a whole.
Now, there was some speculation that it might also affect the U.S. dollar negatively as such a big jump, in the treasury holdings might erode the investor confidence, but the sheer panic of such a move might actually create demand for the U.S. dollar as a safe haven in times of uncertainty, as well as the prospect of possible higher rates and higher yields could also add to the upside of the dollar. There are a few things the U.S. could do to offset the damage as well, which is worth mentioning.
The Fed could for example, opt to buy a lot of the increased supply in order to mitigate the supply and demand imbalance. And that’s tried to basically curb the shock it would create yields and interest rates. But that is obviously just purely speaking about it from my side. I’m not sure whether there are even allowed to buy that amount. But that is the possible effects that it can have.
Obviously the widespread panic will just cause massive risk of flows. And then turning to based on that to the second part whether China would actually do something like that, it’s important to remember that it would certainly hurt the U.S. Dollar, but it would also hurt the world economy in ways that would also cause a lot of pain for the Chinese economy as well. So just looking at the U.S. alone, looking at the OEC information we have on this table, we can see that the U.S. is basically 20% or consists 20% of China’s total exports. So such a hit to the U.S economy as well as the world economy would be a massively, massively negative input for China as well. Looking at the trade balance, we can see that they normally export between 2.4 trillion versus 1.5 trillion imports.
So a massive knock to their exports from a world panic will obviously be very negative for them as a country as well. So looking at everything, I would say in my personal opinion, it would be very unlikely for them to do that. as the negative consequences for China will be just as negative for the U.S. So it’ll be a type of cut your nose to spite your face type of move. And that just seems unlikely for me, as a possibility. But anything is possible.
We need to be prepared for such a type of move. I think a threat of doing it by maybe dumping a smaller amount as a threat, would probably be enough of a threat to get the U.S. and the world’s attention and would be enough as a leverage to help them with negotiations and stuff like that as opposed to trying to dump the whole lot.
But again, that’s just me speculating, but that should give you a little bit more insight on what would happen and what the likelihood is of them actually going forward with something like that.