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China's U.S. Debt Portfolio Will Not Be Weaponized for the Trade War

May 22, 2019 in Economics

By Daniel J. Ikenson

Daniel J. Ikenson

The U.S.-China trade war has reignited debate over the question
of whether Chinese ownership of U.S. government debt is an asset
that Beijing will weaponize. In other words, is the possibility
that the Chinese could sell off large swaths of their $1.1 trillion
holdings of U.S. treasury securities, causing bond prices to fall
and interest rates to rise, something that should concern U.S.
policymakers? Although profligate spending and an accumulating
national debt may well be the toxins that eventually destroy the
U.S. economy, the fact that the Chinese own some of that debt
neither gives Beijing leverage over U.S. policy nor does it present
a threat to the U.S. economy.

The fact that the Chinese
own U.S. government debt neither gives Beijing leverage over U.S.
policy nor does it present a threat to the U.S. economy.

For starters, consider why the Chinese buy U.S. debt in the
first place. For two decades, the Chinese have been purchasing U.S.
treasuries not as a favor to the citizens of the United States, but
because it has been in China’s interest to do so. Nobody in
Washington forces or begs the Chinese to buy U.S. debt. All by
themselves, the Chinese (like investors at home and across the
globe) see the value proposition. It just so happens that U.S.
government-issued debt securities are considered the least risky
investments in the world. Investors know their assets are safe,
accessible, and guaranteed to be repaid virtually on demand.

That’s not to say Americans haven’t benefited handsomely from
China’s investment decisions. The inflow of Chinese (and other
foreign) capital to U.S. debt and equity markets has helped keep
interest rates well below historical averages, effectively serving
to subsidize U.S. consumption, which, in turn, has kept Chinese
factories—as well as factory workers, software engineers,
designers, accountants, and sales representative in other countries
(including the United States)—humming along for decades.

Another reason for China’s appetite for U.S. treasuries is that
purchasing dollar-denominated assets helps prop up the value of the
dollar, which is an outcome that has been favorable to Beijing from
an exporting perspective because U.S. demand for Chinese goods
tends to rise with the value of the dollar. Meanwhile, over the
years, a strong or strengthening dollar has helped preserve the
value of China’s existing portfolio of U.S. debt and other
dollar-denominated assets.

In summary, U.S. treasuries are attractive investments to the
Chinese because of their limited risk, relative liquidity, impact
on U.S. interest rates (i.e. demand for Chinese goods), and impact
on the value of the dollar (i.e., demand for Chinese goods; value
of Chinese-owned U.S. asset portfolios).

Second, even if China did want …read more

Source: OP-EDS

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