The road ahead keeps getting tougher for China in the context of the Coronavirus Pandemic with the Trump administration stepping up the heat on the mighty Dragon. Recently, the United States President Donald Trump threatened to scrap the trade deal with China, if the latter failed to keep its commitment of buying at least US$200 billion more worth of American goods and services than it did in 2017. This includes about US$40 billion in agricultural goods, under phase one of the trade deal.
Merely days after threatening Beijing with dire consequences if it fails to honour the first phase of the trade deal, which would necessarily mean the imposition of fresh import tariffs on the export-based economy of China, news reports now suggest that White House officials have discussed the “nuclear option,” that is, cancelling some or all of around US $ 1.1 trillion debt that the United States government owes China. This comes amid calls for compensation from China.
Analysts say that it is unlikely that the Pentagon will resort to such a drastic measure that would destroy the creditworthiness of the US government when it comes to paying its bills and erode investors’ faith at a time when the Trump administration is looking to ramp up new issuance to pay for a series of programmes that are being kickstarted in order to mitigate the economic devastation being caused in the country by COVID-19.
The move could turn out to be self-harming and counterproductive for the United States, but the mere fact that such a move was even discussed by the Trump administration officials has sparked panic and fears of a huge US $ 1.1 trillion loss within the People’s Republic of China.
Beijing is now considering the option of insulating itself from the risk of the Trump administration effectively defaulting on debt holdings, and is now looking to reduce its vast holdings of the US Treasury securities in the coming months. China risks losing out on an entire economy if Trump decides to rescind debt obligations which has set panic in the country that is drawing flak from around the world for slipping the globe into a Pandemic.
One-third of Beijing’s US$3 trillion in foreign exchange reserve holdings, are held in US treasuries and the fresh deliberations among White House officials, therefore, mean a huge crash in China’s formidable forex reserves.
China cannot offload US treasuries by offering them for sale, even though it will cause a sharp fall in US Dollar prices and push down US bond prices, because it will also lead to a global financial catastrophe that
China itself cannot afford at this juncture.
What Beijing would be looking to do is to cut down on US treasury bill purchases, and as the old bills expire without getting replaced with new ones, China would be gradually able to reduce the volume of its holdings of US Treasury securities.
Iris Pang, Greater China chief economist at ING Bank said, “In the coming months, [China could] halt its Treasury purchases to send a clear signal of its intentions.” He added, “If it decides to do that, it could make actual sales [of its other holdings] at a later date.”
In fact, there have always been demands within Beijing to reduce the share of US Treasury bills in its forex reserves, and as per a latest US Treasury Department report, the share of such Treasury bills in China’s holdings have gone down to US $ 1.09 trillion from a record high of US $ 1.32 trillion in November 2013.
Chinese analysts claim that the US Dollar can be weaponised by the United States government, and China’s foreign exchange regulator, the State Administration of Foreign Exchange revealed last year that the country has been steadily diversifying its holdings that are currently dominated by US Dollar dominated assets.
If the Trump administration were to take the drastic measure of effectively defaulting on the debt it owes to China, then it will most probably backfire because interest rates would go on to soar due to reduced creditworthiness of the US government as a borrower.
The cost of borrowing itself would go up for the United States at a time when the American administration is considering measures to revive its Pandemic-battered economy. But the threat for China is real, given that this is an election year for Trump who has already made a big poll issue out of Beijing’s Coronavirus cover-up.
Trump would, of course, want to come out looking like a bold leader who hit back at the country that caused the Pandemic in the first place. This is why China is in Pandemic mode and the entire administration is looking to reduce the share of US Treasury bills in the forex reserves in order to mitigate the extreme losses that it will suffer in the event of Trump administration actually cancelling the debt the United States owes to China.
