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Pragmatic Capitalism

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What if China Sells all of its U.S. Treasuries?

Here’s another common question I get in the forum:

Question: Cullen, what would happen if China [or XYZ Country] dumped all it’s US dollar denominated bonds?”

Answer:  Someone else would own them.  :-)

That’s like saying “what if Vanguard dumped all of its XOM shares?” Well, someone else would own them. Vanguard would sell their XOM shares and obtain cash and someone else would get rid of their cash and own (Exxon) XOM shares.

Vanguard owns about 5% of all outstanding XOM shares so it’s a huge amount. And if they were a forced liquidator or worried liquidator then it could put some pressure on prices. But it wouldn’t change the fundamentals of XOM. And so any major price deviations would be largely unwarranted.

If China decided to unload their holdings of U.S. Treasuries in a low inflation environment then my guess is that savvy bond traders would gladly scoop them up and exchange their paper dollars for something that generates a real return.  China would be left holding a bunch of dead presidents that just sit there collecting dust and losing purchasing power.  So what?  The point being, unless the fundamentals supporting US government debt change (mainly, the fact that the USA produces 22% of all global output) then the fundamental support under the quality of US government bonds doesn’t change just because China decides to reallocate out of bonds.  Just like Vanguard deciding to own fewer shares of XOM doesn’t mean that XOM is suddenly a bad company that isn’t worth holding at current prices.

Further, as long as inflation isn’t spiralling out of control then there’s no reason to worry about private bondholders wanting to own US government issued financial assets. After all, in a low or moderately high inflation environment there will be demand for government bonds because they’re the equivalent of cash in the long-run plus an interest payment. The worrisome environment is one in which inflation is very high and underlying productive output is in terminal decline thereby making the US currency (and government issued bonds) potentially worthless.  But we should be very clear when we differentiate between a solvency crisis and an inflation crisis. Although a currency issuing country is not immune to currency crisis it is not susceptible to solvency crisis in the same way that a household or business is.

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC.Orcam is a financial services firm offering low fee asset management, private advisory, institutional consulting and educational services.Cullen is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
Cullen Roche

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