America is about to go another $1 trillion in the hole. The people who hold U.S. debt are starting to get nervous.
By WILLIAM PESEK
April 12, 2018
With money you can buy a house, but not necessarily a home. President Xi Jinping can surely relate to this Chinese adage as he considers the dubious mortgage Beijing holds at the moment.
The U.S. may have built a giant, vibrant economic house on the proverbial hill, but bankers in China, Japan and elsewhere in Asia possess the deed. Together, 10 Asian economies hold more than $3 trillion of U.S. Treasuries—nearly 15 percent of the total national debt—as Washington borrows with abandon. That’s leverage over Donald Trump’s White House, and don’t doubt for a minute that Communist Party bigwigs in Beijing know it.
With the U.S. deficit set to soar past $1 trillion, threatening to send the U.S. debt-to-GDP ratio to a level not seen since the 1940s, Xi’s government is dropping not-so-subtle hints about calling its $1.2 trillion of loans to Washington. The first shot across Trump’s bow came from Cui Tiankai, China’s ambassador to the U.S. In a March 23 Bloomberg interview, he hinted Beijing might scale back U.S. debt purchases, a step that would send shock waves through global markets. “We are looking at all options,” Cui said.
More recently, a top adviser to China’s central bank, Fan Gang, said it’s time to diversify. “We are a low-income country, but we are a high-wealth country,” Fan said April 9 in a speech at the annual Boao Forum. “We should make better use of capital. Rather than investing in U.S. government debt, it’s better to invest in some real assets.”
These aren’t idle threats. Xi has zero reason to think China—and its vast state wealth—has found a home with the “America First” president. It would be complacent, too, to conclude Xi’s soothing words on April 10 (“dialogue rather than confrontation”) will ease tensions. Trump won the White House claiming China is “raping” American workers. A few vague pledges by Xi to open markets, cut auto tariffs and protect intellectual property rights won’t persuade Trump to drop a core belief—and Xi knows that.
Also, Xi thinks in decades. Concrete steps to give Trump what he demands could come well after the 2020 U.S. election. White House inhabitants come and go, but Xi’s massive “Made in China 2025” plan yields to no one. Last month, Xi’s party made him the helmsman indefinitely, perhaps for life. Trump will be gone by January 2025 at the latest.
To maintain power, Xi must generate 6.5 percent growth annually and morph China into a leader in aerospace, biotechnology, electric vehicles, high-speed rail, renewable energy, robotics, software and telecommunications. Given the scale of the enterprise, Trump is more a risk-management challenge to Xi than a long-run disrupter.
The short run, though, is sure to be busy. As scandals and investigations mount, a caged and paranoid White House is desperate to change the narrative. What better way than an escalating trade war that cheers Trump’s base without requiring congressional approval?
Yet Team Trump mustn’t take its top banker, China, for granted. On top of roughly $150 billion worth of tariffs on mainland goods, Trump is demanding that Beijing curb support for high-tech sectors. That’s an economic red line for Xi and his signature 2025 project. Liu He, vice premier overseeing economics and finance, balked, according to local press reports. This standoff alone should give pause to anyone hoping cooler heads will prevail. So should Beijing’s assertive and creative pushback against tariffs, targeting the farm goods, bourbon, machine tools and motorcycles beloved in Trump country. In the end, Xi’s China won’t back down.
Trump may think he has all the leverage, but Xi can always play the Treasuries card right back. Bond traders would be remiss to think he won’t if Trump escalates the tariff arms race. One reason markets have taken warnings from Cui and Fan in stride is the mistaken belief we’ve been here before.
In June 1997, then-Japanese Prime Minister Ryutaro Hashimoto rocked markets during a speech at New York’s Columbia University. Hashimoto warned that Tokyo could always dump its dollars to make a political point. One such episode: tense U.S.-Japan auto talks during the mid-1990s. “Several times in the past,” he revealed, “we’ve been tempted to sell large lots of U.S. Treasuries.” Thankfully, Tokyo didn’t trash the linchpin asset of world trade.
The threat Hashimoto telegraphed that day would be echoed in Beijing 14 years later. In August 2011, China looked on angrily as President Barack Obama cozied up to Taiwan, which Beijing views as a renegade province. The state-run People’s Daily newspaper spoke for many in the halls of power at the time, declaring: “Now is the time for China to use its ‘financial weapon’ to teach the U.S. a lesson if it moves forward” with arms sales to the island democracy.
Even the secretary of defense at the time, Leon Panetta, chimed in: “Attempting to use U.S. Treasury securities as a coercive tool would have limited effect and likely would do more harm to China than to the United States.” Seven years on, Panetta is right in one respect: There is indeed a mutually assured destruction dynamic at play here. By dumping Treasuries, Xi’s government would sustain massive paper losses and slam a key export market. A resulting surge in debt yields could savage U.S. jobs and consumption—a dreadful outcome for export-reliant China.
There’s also how the turmoil affects Xi’s reform drive. Tackling dueling bubbles in debt, credit, property and pollution without crashing the world’s No. 2 economy is hard enough in the best of times. A global trade brawl raises the stakes and the risks.
Even so, Beijing has valid reasons for buyer’s remorse as U.S. debt skyrockets. In February, Director of National Intelligence Dan Coats said Washington’s $21 trillion-plus debt “truly undermines our ability to ensure our national security.” On April 9, the Congressional Budget Office said the annual budget deficit will top an eye-popping $1 trillion by 2020.
Beijing, not surprisingly, looked askance at Trump’s Republican Party in December passing a $1.5 trillion tax cut the economy didn’t need. It’s not the first time. Long before Trump, a real estate tycoon who touts bankruptcy filings as good business, arrived in the White House, China fretted about the dollar. In 2009, then-Premier Wen Jiabao made an impassioned plea about Washington’s post-Lehman-Brothers-crisis borrowing binge.
“We have made a huge amount of loans to the United States,” Wen said. “Of course, we are concerned about the safety of our assets. To be honest, I am a little bit worried.” Wen urged the U.S. “to honor its words, stay a credible nation and ensure the safety of Chinese assets.” Wen was articulating Beijing’s Catch-22: Even though it has too many U.S. bonds already, there are few viable alternatives.
The Obama White House trod carefully with its Asian benefactors. In 2009, Hillary Clinton put debt diplomacy over human rights on her maiden trip to Beijing as secretary of state. Political prisoners took a back seat to how “our economies are so intertwined,” as she put it. That same year, according to cables released by WikiLeaks, Clinton asked Australia’s then-Prime Minister Kevin Rudd for advice: “How do you deal toughly with your banker?”
Trump’s trade war, though, is the wrong answer to a different question—the right question, actually. Yes, Beijing is an unfair trader. It subsidizes local players, hinders foreign firms from competing, contradicts World Trade Organization rules and cribs intellectual property. But given the uniquely symbiotic relationship between the two countries, China and the United States must sit down and negotiate in good faith, not duke it out via dueling statements and tweets.
Yet Trump is playing the most dangerous game of all: trolling his bankers. An unspoken assumption behind the December tax cut is that China, Japan, Taiwan, India, Singapore and South Korea will dutifully buy more U.S. debt. That’s now in doubt. Washington’s fiscal irresponsibility—and new weak-dollar policy—are reason enough to question its creditworthiness. But Trump shouldn’t be giving China justifications to make history’s biggest margin call, shaking America’s economic foundations. For Emperor Xi, it’s the ultimate trump card.
William Pesek is a Tokyo-based author of Japanization: What the World Can Learn from Japan’s Lost Decades. He has been a columnist at Barron’s and Bloomberg.