The nuclear option China could take in trade war with the US
Retaliatory tariffs may only be the beginning of Beijing’s counter attack
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The nuclear option China could take in trade war with the US
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Retaliatory tariffs may only be the beginning of Beijing’s counter attack
Melissa Lawford
President Xi Jinping is looking to turns the screws on Donald Trump
President Xi Jinping is turning the screws on Donald Trump Credit: Kevin Lamarque/REUTERS
President Xi Jinping is on the offensive. China’s surprise announcement of 34pc retaliatory tariffs on US goods triggered a fresh wave of stock market falls on Monday.
“Beijing saw the way things are going and thought this might well be the opportune moment to apply more critical pressure on the US,” says Duncan Wrigley, chief China economist at Pantheon Macroeconomics.
The US-China stand-off triggered a 13.2pc fall in the Hong Kong’s Hang Seng index on Monday, the largest one-day move since 1997, and China’s CSI300 blue-chip index also fell 7pc.
China’s foreign ministry has labelled Donald Trump’s tariffs “economic bullying” – but the big question now is how much more is to come from Beijing?
In theory, Xi is sitting on a potentially nuclear option as he turns the screws on Trump.
China is the second-largest holder of US debt, known as treasuries, in the world. If it opted to dump this government debt, the blow to the US would be seismic.
According to the US Treasury, in January, China held $761bn (£592bn) in American government bonds. This was second only to Japan (which holds more than $1 trillion) and nearly a tenth of all foreign-held US government debt.
Robin Brooks, senior fellow at the Brookings Institute, says the real figure is even higher – likely around $1 trillion – after accounting for the unknown sums that China holds via custody accounts in Europe.
If China embarked on a mass sale of its US treasuries, the value of the debt would plunge and yields would soar. This would drive up US government borrowing costs and hammer the public finances in a highly destabilising move.
But the scenario is highly unlikely, not least because the pain for China would be huge.
Marcello Estevão, chief economist at the Institute for International Finance (IIF), says: “It would be self-defeating because it would very much hurt China.”
Mark Williams, chief Asia economist at Capital Economics, says: “China dumping treasuries would be the equivalent of lobbing a hand grenade at someone sitting across from you in a room.”
Trump would get hit, but Xi would be burned too.
Economic self-harm
The Chinese state and its banks own around $3 trillion in dollar assets. “That’s roughly the value of UK GDP,” says Williams. “There is no way to offload $3 trillion of assets in a hurry.”
If China started selling, it would trigger a plunge in dollar values, immediately hammering the value of all of its remaining dollar holdings. And China would not have many options for what it could do with the proceeds of what it did sell, says Williams.
“If it brings them back to China, the renminbi appreciates,” says Williams. This would make China’s exports far more expensive for the rest of the world, hitting its ability to export.
Moreover, the economic self-harm in China would potentially be for nothing, as the US Federal Reserve would step in to stop the damage in the US before it could really get started.
“In the worst-case scenario that China announces they’re going to sell their treasury holdings, for sure, yields in the market would spike. It would be a huge shock, but the Fed would very quickly come in and basically do a massive QE [quantitative easing] programme and push yields all the way back down,” says Brooks.
“The weapon that China has is basically to tighten US financial conditions and tank the US economy. But given that the Fed can step in, that weapon just isn’t very credible.”
The pandemic offers a playbook for the action the central bank could take.
Back in March 2020, as emerging market central banks sold off Treasuries because they had to make interventions at home to support their currencies, yields on US treasuries rocketed from 0.5pc to 1.2pc within a week.
“I think that kind of magnitude is probably a lower bound for what would happen if China did announce something – not that I believe they will,” says Brooks.
Back then, the Fed stepped in swiftly to purchase around $1.2 trillion in US treasuries to bring yields back down.
However, an aggressive Fed quantitative easing programme could mean major losses for the central bank further down the line if inflation picks up, as is likely in the US in response to Trump’s tariffs.
But this would not be worth it for China, particularly also considering that the US could also follow up with its own nuclear options, says Wrigley.
“It could impose sanctions on China in the way it did on Russia to stop Chinese banks accessing dollars,” he says.
The impact on global trade would be unthinkable. But up until Wednesday, for many market analysts, so was the prospect of the trade tariffs Donald Trump has just imposed.
