Whitehouse could force China cut US debt in response Covid-19

Whitehouse China

Whitehouse officials have already considered the idea of canceling all or part of the US$1.1 trillion debt owed to China

China could be forced to move to reduce vast holdings of US Treasury securities in response to a resurgence in trade tensions and a war of words between Whitehouse and China due to questions over the origins and handling of the COVID-19 outbreak, insiders say.

We have been told that Whitehouse officials have debated several measures to offset the cost of the coronavirus outbreak, including canceling some or all of the nearly US$1.1 trillion debt that the United States government owes China.

Some insiders add that the US is highly unlikely to take the “nuclear option,” which is defaulting on any and all debt held by China. The mere fact that the idea has been discussed could well prompt Beijing to seek to insulate itself from the risk by reducing its US government debt holdings. Other countries have also followed the same course of logic when it comes to seeking compensation for costs related to the outbreak.

The discussion of China’s financial obligation to the US government has come about as US President Donald Trump and other American officials have ramped up their criticism of Beijing over the coronavirus outbreak

 and threatened new import tariffs to penalize China.

But any move to cancel the debt owed to China – effectively defaulting on it – would be counterproductive to US interests because it would likely destroy investors’ faith in the trustworthiness of the US government to pay its bills, most analysts warned.

An aggressive move regarding debt fault would likely send US interest rates soaring, making borrowing more costly for the government, as well US companies and consumers, and in turn, strike a sharp blow to America’s already fragile economy due to COVID-19. 

The US Treasury’s two-year yield continued to trade near record low levels this week, suggesting market traders and fund managers are largely shrugging off what is widely seen as a far-fetched idea that the US could cancel some or all of China’s debt.

Nevertheless, the news that the idea was discussed by top US officials is likely to raise concerns among Chinese leaders in Beijing regarding the growing risks of holding large amounts of US debt at a time when relations appear to be deteriorating by the week, if not the day.

If China has no choice in the scenario, it would want to avoid quickly offloading its US debt without first considering other punitive measures from the US.

Chinas actions or inactions could trigger a crash in the US dollar and financial markets around the world by flooding the market with US Treasuries for sale, which would result in pushing down US bond prices and cause yields to spike. But that would also ignite a global financial catastrophe, hurting China as well.

Instead, China could cut back or stop buying the new US Treasury, the best solution for the US and President Trump. This would gradually reduce China’s holdings of US government securities as old ones expire and are not replaced.

In the meantime, we are being told China maybe consider imposing tariffs of its own or reducing its US agricultural purchases. China has agreed to buy an additional US$200 billion worth of US products and services over the next two years compared to 2017 levels as part of the Whitehouse phase one trade deal signed in January 2020. But with the coronavirus outbreak has raised questions about China’s ability to meet these commitments. At the same time, President Trump said that he would terminate the deal if China does not buy the amount of American products it has promised.

In the US, GOP leaders have always been calling for China to diversify its US$3 trillion in foreign exchange reserve holdings, around one-third of which are held in US Treasuries. According to the latest US Treasury Department report, China’s holdings slipped to US$1.09 trillion in February from a peak of US$1.32 trillion in November 2013. 

Surprizing China was surpassed by Japan last year as the largest foreign holder of US Treasuries, which most Americans were not aware of.

“There’s a strong urge for countries like China and Russia to move away from the US dollar. A reality which both countries have been aggressively pursuing over the past 3 years.

 This is simply because the US dollar can be weaponized by the US government,” as demonstrated by the US government of cutting off foreign individuals, companies, and governments from the global US dollar financial transaction settlement system, significantly complicating their ability to conduct business.

China’s foreign exchange regulator, the State Administration of Foreign Exchange, revealed a snapshot of the composition of China’s foreign exchange reserves as of 2014. They stated that China been steadily diversifying its holdings away from US dollar assets and into other riskier currencies as well as gold.

US dollar assets accounted for 58 percent of China’s total US$3.84 trillion in reserves at the end of 2014, down from 79 percent in 2005 and below the global average of 65 percent.

A recent estimate is that China sold around US$30 billion in US dollar assets in March to defend the yuan’s exchange rate from the sharp US dollar appreciation that month. China’s foreign exchange reserves fell significantly in March 2020, the biggest fall since November 2016.

It is assumed China’s US dollar holdings consisted of 70 percent US Treasuries, 15 percent US government agency debt, and 15 percent equities.

As a result, China could be forced to toughen its US policies if it no longer earns US dollars from its exports to the US because of a significant US-China decoupling. If that were to happen, China could sell its US Treasury holdings for yuan, seeking to engineer a collapse in the US dollar to end its status as the ruling currency. 

Whitehouse officials continue to analyze the situations continuously.

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