PrepperNomics 107:  Understanding Chinese Holdings of US Treasuries

I briefly referred to Chinese holdings of US Treasury securities in my post on Economic Collapse.  Since that time the administration has begun negotiations with China over trade.  These negotiations are likely to go on for some time, but that hasn’t gotten in the way of everything from a stock market reaction to articles in the Prepper Media saying its TEOTWAWKI.

The perceived problem in Prepper Media, (sort of like the mainstream media, but loonier on economics) is that China may react by dumping its holdings of US Treasury debt, triggering . . . something bad.  ☹  This has even been referred to as China’s “nuclear option”.

Yeah, it’s going to be one of those challenging posts where I try to talk about something political without being political.  The funny thing is I am more likely to annoy the hysterical Prepper Media than stumble into a mainstream political discussion.  Let’s see how well I do!  😊

Step 1:  China sells its bonds

China supposedly holds about $600 billion of US Treasury securities with various maturities.  To put this in perspective, the national debt is $20 trillion, so $600 billion is a large number, but there are obviously many other people and institutions that own US Treasury securities.  In the Prepper Media, abruptly selling $600 billion of US Treasuries leads straight to Armageddon, Do Not Pass Go!  What would really happen?

China cannot just hand over the bonds and demand immediate payment.  The bonds have not matured.  They have to sell them in the open market.  They could do this gradually and the market would absorb the bonds and they would simply pass to buyers who wanted them.

The concern would be if they tried to sell them rapidly.  In that case the prices of US Treasury securities would decline, and interest rates would go up.  If prices decline the Chinese would be taking a loss.  The more the prices decline, the bigger the immediate loss the Chinese would take.  So instead of hurting us, China would be hurting itself.

It is also worth noting that if the bonds became sufficiently low in price, the Federal Reserve could decide to start buying bonds at a nice discount to what they were originally sold for.  Wouldn’t you like to be able to sell $600 billion worth of bonds, then buy them back for $550 billion?  I’d take that deal!

Step 2:  China now has dollars

China would receive dollars for its bonds, so at this point they have traded debt in the form of bonds for debt in the form of Federal Reserve Notes.  (Take a look at the currency in your wallet.)  They have taken a loss, and yet they are still in a position that the US government owes them money.  In order to really get out of US debt, they need to get rid of the dollars.  The only way to get rid of US dollars is to spend them.  Since the US dollar is a reserve currency, they could spend the dollars either in the US, or elsewhere.

If they spend the dollars outside the US, all that has happened is US debt has gone from being held by China to being held by somebody else.  If they spend the money in the US, the result is approximately $600 billion of additional economic activity in the US economy, and a significant decline in the trade deficit.  The Chinese would be buying goods and services from the US.

However, this is what the current trade negotiations are trying to achieve, a reduction in the trade deficit.  If China spends money in the US, they are doing exactly what the US needs for them to do to narrow the trade deficit, which was the original point.  In a nutshell, US debt in Chinese hands represents future Chinese purchases of US goods.

Step 3:  Economic Stimulus

Now you may recall that whenever the US government feels we need a little “economic stimulus” the answer is to spend money.  Early in the Obama administration a $750 billion dollar “stimulus package” was passed.  Currently there is discussion of a $1.5 trillion infrastructure package that would also provide economic stimulus.  If someone other than the US government spent hundreds of billions of dollars in the US, wouldn’t that also provide stimulus?

In the case of China, we are talking about $600 billion, so we are in the ballpark of a nice little stimulus package, without increasing the debt of the US government.  In fact, the extra economic activity would result in higher tax revenues and lower fiscal deficits as well!  Jobs would be created.  We get a nice boost from the whole exercise.

Summary

The US debt in Chinese possession represents $600 billion of future spending in the US, not a “nuclear option”, whatever that is.  If the trade negotiations result in spending in the US occurring sooner rather than later, that is good for the US economy.  That much spending would create jobs, increase wages, and generally be positive for the US economy.

Sorry Prepper Media, the sky is not falling due to trade negotiations with China.