NIKKEI ASIAN REVIEW

Beijing may be mulling cuts in vast US bond holdings in reply to Trump trade threats

By William Pesek

January 15, 2018

America has built and runs a robust economy, thanks to huge Treasury bills held by Asian countries, foremost among them being Beijing’s $1.2 trillion holdings.

As Donald Trump seeks leverage against China, the tycoon-turned-president appears to have forgotten the basics of his former day job. Beijing may be about to remind him about borrower/lender mechanics.

The U.S. built a huge, innovative and enviably wealthy economy, but Asia holds the mortgage. Beijing owns $1.2 trillion of U.S. Treasuries, and Tokyo $1.1 trillion. Hong Kong has $192 billion, Taiwan $182 billion, India $141 billion, Singapore $130 billion.

This $3 trillion-plus of IOUs in the hands of 10 Asian economies enables Washington to live beyond its means. Their continued support is more important than ever as President Trump’s tax cut adds another $1 trillion to federal budget deficits. It might not be harder to raise, though, if China were ever to draw down its dollar holdings. If that happens, expect turmoil in debt markets on a scale not seen in a decade or more.

Yields on 10-year U.S. bonds jumped to the highest since March on a Bloomberg News report that Chinese officials reviewing reserve holdings favor reducing dollar purchases. This risk slammed a market already on edge over tighter central bank policies and rising government issues. On Jan. 10, bond guru Bill Gross told Bloomberg he has “gone short” on U.S. Treasuries apparently making Beijing wary.

Rajeev de Mello of Schroders Investment Management told CNBC: “This warning shot means that they (Chinese officials) take seriously the threat of some [U.S.] trade sanctions and there might be some tit-for-tat. And that’s the message that worries me the most for emerging markets and for Asian currencies and assets.”

China is making is clear, he said, that we “will not just lay passive if the U.S. administration imposes tariffs. I think that’s the position they want to be in, that they are a major player and not a small country on the receiving end of the U.S. big stick.”

No one can say whether Xi Jinping’s government will actually call its loans, but there are two obvious reasons to make that threat. One, insurance against the trade war Trump promised on the campaign trail. Two, America’s AAA status is no longer ironclad in the erratic Trump era. So Beijing’s investments are no longer as secure as they were.

The first raises doubts among Sinologists. They say Beijing, after all, has more nuanced ways to challenge Trump’s “America First” agenda. That includes regulatory steps to limit market access, a strategy China last year employed against South Korea with reasonable success. “Beijing,” cautions Michael Hirson of Eurasia Group, “has long recognized that injecting politics into its Treasury purchases is a blunt tool that could quickly backfire.” President Xi, he adds, “has strong reasons to continue this approach in order to achieve his key domestic and foreign policy priorities.”

Or does he? On the campaign trail, Trump pledged to brand China a currency manipulator and slap tariffs of between 35% and 45% on mainland goods. Late last year, Trump reminded Xi that the threat is active with a sudden probe on aluminum imports. Trump, if his Twitter feed is any guide, feels betrayed that Xi has not persuaded North Korea to denuclearize. But Xi has valid reasons to remind Trump that Beijing holds a deed vital to his ability to service new debt issuance.

This has dawned on Beijing before. In August 2011, for example, it considered punishing Trump’s predecessor, Barack Obama, for cozying up to Taiwan. “Now is the time,” state-run People’s Daily argued in an editorial on the topic, “for China to use its financial weapon to teach the U.S. a lesson.”

To bond aficionados, the threat echoed one 20 years ago by then-Japanese Prime Minister Ryutaro Hashimoto. At a June 1997 symposium at New York’s Columbia University, Hashimoto noted that foreigners buying debt was how Washington “maintained” its excesses. Then, he savaged markets by admitting that “several times in the past, we have been tempted to sell large lots of U.S. Treasuries” to gain diplomatic leverage. One such scenario, Hashimoto said, was during contentious auto-sector talks.

Pyrrhic victory 

Granted, dumping dollars might be a pyrrhic victory. U.S. debt is the linchpin of global finance. China would suffer huge paper losses on its dollar bets if markets plunged, tempting Tokyo and other Treasuries whales to sell, too. Any surge in borrowing costs would boomerang as American consumers bought less. Yet unnerving markets already struggling amid high sovereign-debt issuance and central-bank tightening would surely get Trump’s attention. Especially if Xi’s maneuvers halt Wall Street’s bull run, one vital to Trump’s legitimacy.

The second motivation traces back to an episode in March 2009, when then-Premier Wen Jiabao complained Washington’s post-Lehman-Brothers-crisis bailouts would dilute the value of Beijing’s dollars. On the eve of a Group of 20 meeting, Wen said: “We have made a huge amount of loans to the United States. Of course, we are concerned about the safety of our assets. To be honest, I am a little bit worried.” He called on the U.S. “to honor its words, stay a credible nation and ensure the safety of Chinese assets.”

Wen’s angst proved prescient in August 2011, when Standard & Poor’s became the first major credit rater to downgrade the U.S.

Washington’s two remaining AAA ratings may be cold comfort as Trump borrows with abandon and hints at pursuing a weaker dollar. It hardly helps that Trump sometimes raises the specter of defaulting on Treasuries as a negotiating ploy.

As president, candidate Trump said in May 2016, “I would borrow knowing that if the economy crashed you could make a deal. And if the economy was good it was good so therefore you cannot lose. It is like you make a deal before you go into a poker game. And your odds are much better.” Though Trump tried to walk back his comments, he had made similar ones before.

Xi’s China has reason to be afraid. In touting his successful business record, Trump points to four major bankruptcies as shrewd deal making. Optimists might say Trump will respect the “full faith and credit” of Treasury debt that prevailed since the days of Alexander Hamilton, America’s first finance minister. So far, though, this president has managed his White House like an extension of Trump International, running roughshod over diplomatic and financial conventions.

Trump has some serious finessing to do with Washington’s bankers, particularly China. That is, if it is not already too late for his art of the deal. Beijing will not be easy to convince.

 

William Pesek is a Tokyo-based journalist and author of “Japanization: What the World Can Learn from Japan’s Lost Decades.” He has written for Bloomberg and Barron’s.

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