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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.

  1. LVG

    Bahhh. I never loved Disqus, but it’s probably an improvement over the default comment section in this site. Big problem though – it appears to have deleted all of the old comments.

  2. AB

    Pettis explains this beatifully. It might take some googling, but it is out there. Cullen, I am a bit surprised that decided to make a post out of your answer. There are obvious implications if Chinese, European, Japanese, other EM, or Americans end up buying these assets. Also, what does China buy instead, if anything at all? These options all have interesting international accounts ramifications.

  3. Willy1964

    1. the yuan would appreciate against the USD, thus killing their exports. But chinese (price) inflation would be lower.
    2. the US Current Account Deficit would shrink and the US would be forced to live less beyond its means. And it would push US interest rates higher.

  4. lessismore

    I won’t use discus, facebook, twitter or any of the other social media mediators for comments.
    I do not think people should be forced to create yet more online
    accounts. I do not think blogs should compel readers to use and support
    companies they would not choose on their own.

  5. Cullen Roche

    You don’t have to login through Disqus here. I left the guest option open specifically to avoid that. This comment system is has all the same features of the original one plus more. What do you not like about it?

    Thanks for the feedback!

  6. Vincent Cate

    China could always print and spend enough Yuan to keep the value from going up compared to the dollar. Imagine they just kept printing Yuan and buying dollars, and then allocated the dollars equally into 4 things, S&P 500, oil , gold, and dollars. They could keep doing this until the Yuan was as low as they wanted. It would either work and they would stop or they would end up owning all the S&P500, oil, gold, and lots of dollars. Selling Treasuries does not necessarily mean the Yuan must go up.

  7. Vincent Cate

    The only way the US Treasury is currently able to unload around $1 trillion in bonds each year is that the Fed is making new money and buying about $1 trillion in bonds. If the Chinese tried to dump their $1 trillion in bonds then either the Fed would have to buy $2 trillion in bonds or the price of bonds would crash. Or both.

  8. Geoff

    Vincent, how do you know that “the only way the US Treasury is currently able to unload $1 trillion bonds each year” is through QE? That is a very strong statement with no proof to support it.

  9. Vincent Cate

    Bernanke hinted that he might start tapering down the monthly QE and interest rates have about doubled since then even though he backpeddled on that hint as fast as he could.

    If the Fed were not buying like crazy then the USA would be like Greece. Interest rates would be far higher and the government would be clearly bankrupt as the interest alone would clearly be unsustainable.

  10. Geoff

    Haha, I assume the only reason you would compare the USA to Greece on this site is if you were trying to provoke a reaction from other posters. 🙂

  11. willid3

    dont think we would be like Greece. other than being 2 countries there is very little in common. Greece shares a currency with several other nations. not all of whom look like they do. The US has its own currency. so we control our currency, they can’t. and among other things, our is the world reserve currency, and lots of commodities are priced in it (especially oil). and so far none of the oil producing countries really wants to change that (though Iran tried to change to the Euro. wonder how that worked out for them). and not sure that rates would rise that much. cause lets have a reality check here. what other currency could be the world’s reservce? it wont be the Euro (after all that is Greece’s currency). and it wont be Yuan,very few countries will accept it in exchange for goods etc when the world’s economy tried to collapse back in 2008, all the money flowed to the US.

  12. Willy1964

    – The Yuan would go up when China sells Treasuries. Because selling Treasuries means China sees an net inflow of money and that pushes the yuan higher.
    – If China would get rid of capital controls then it would see an outflow of money and would push the yuan lower. But that would cause more chinese credit deflation.
    – China can (literally) print as much yuan as they want. But that wouild push the yuan lower but that will create massive price inflation and will lead to massive civil unrest.
    – China can sell its Treasuries but that would push US interest rates higher, thereby killing their most important export market.
    – Buying the S&P 500, oil, gold simply means selling USD, not buying USD.
    So, no matter how you slice it, no matter what China chooses, it will all be detrimental to China. But don’t be fooled, what ever China chooses it will be detrimental for the US as well. In that regard the US and China are in the same boat.

  13. Vincent Cate

    Imagine Bernanke were replaced by Ron Paul and there would be no more QE at all. Then the US would be like Greece for all practical purposes. Now I know that Obama is not going to put Ron Paul in charge of the Fed, so this is just a theoretical exercise. What makes the US different from Greece is that it can print its own money and it does in large amounts.

  14. Vincent Cate

    Imagine Ron Paul was head of the Fed and has been very clear his whole life that he is against monetizing debt, Fed buying government bonds, printing money, making new money, QE, or anything similar. So even though there was the theoretical possibility that the USA could make money it was in practice not going to happen. In this hypothetical situation (never going to happen in the real world) then the USA would in practice be in the same situation as Greece, not able to make new money.

  15. Vincent Cate

    🙂 Ya, I have been around long enough to know that this should provoke a reaction. But I don’t think I am trolling or just trying to cause trouble. I do think it is an interesting point.

  16. Cullen Roche

    You seem to think there would be no one to buy the bonds if the Fed wasn’t there to do it. That’s obviously not right. Many people, including Bill Gross said this when QE2 was set to end and demand for Tsy bonds remained extremely strong after the program ended.

    Ron Paul might eliminate some of the crazy Fed policies, but he wouldn’t eliminate govt spending. That’s Congresses role. Not the Fed. You’re confusing monetary policy and fiscal policy.

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