|were reports China could sell some of its $1.2 trillion of Uncle Sam’s obligations, although that talk was dismissed in April. “To be sure, it would be one effective, shot-across-the-bow way for the Chinese to strike back aside from retaliatory tariffs, especially if it feels the U.S. has gone too far,” she adds.|
There’s a flip side to the U.S. trade deficit that President Donald Trump rails against—the flow of capital from abroad that covers that gap. It leaves the U.S. vulnerable to other kinds of retaliation.
As the world’s biggest debtor, the U.S. depends on investors abroad to continue to invest in America. And among the biggest investors is the country that Trump is targeting for its big bilateral surplus with the U.S. and its alleged unfair trade practices: China. As the largest holder of U.S. Treasury securities, China helps fund both legs of the so-called twin deficits—the budget shortfall as well as the trade gap.
That makes the U.S. dependent on the kindness of strangers, just like Blanche DuBois in Tennessee Williams’ A Streetcar Named Desire, notes Danielle DiMartino Booth in her Daily Feather advisory. And those strangers can turn testy, as Russia did by dumping half of its holdings of Treasury securities in April after the U.S. placed sanctions on Russian oligarchs and other Russian organizations.
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“The ginormous Panda in the room is China, the reigning holder of U.S. Treasuries, and whether it reacts in similar fashion,” Booth writes. It’s a question that takes on increased import with Trump’s latest threat to add tariffs on an additional $200 of imports from China. Back in January, there were reports China could sell some of its $1.2 trillion of Uncle Sam’s obligations, although that talk was dismissed in April. “To be sure, it would be one effective, shot-across-the-bow way for the Chinese to strike back aside from retaliatory tariffs, especially if it feels the U.S. has gone too far,” she adds.
China has two ways of hitting back at the U.S. financially: by either reducing its holdings of U.S. securities or by devaluing its currency, the yuan, according to Capital Economics. The latter option would require Chinese monetary authorities to sell yuan and buy other currencies, most likely dollars, which would be invested in more U.S. securities.
Even though the yuan has declined against the dollar, it has been more the case that the greenback has strengthened. Measured against a basket of other currencies of China’s trading partners, the yuan has gained ground, The Wall Street Journal reports. That suggests China is not seeking to manipulate its currency for a trade advantage, a false claim Trump made in the presidential election campaign.
As for China precipitously dumping its holdings of Treasury securities, that would be “cutting off their nose to spite their face,” says Gregory Peters, PGIM Fixed Income’s senior investment officer. If their intent would be to inflict higher bond yields—and lower prices—on the U.S. market, the Chinese also would be losers on their remaining stash.
Instead of selling outright, Chinese official investors could simply boycott auctions of new Treasury securities. That could put upward pressure on yields at the margin, just when the Federal Reserve also is paring its securities holdings to reverse its “quantitative easing” enacted to counter the financial crisis and its aftereffects. At the same time, the Treasury is ramping up its sales of securities to finance the wider budget deficit.
Overseas demand for Treasury securities has been weak, Nomura’s head rates strategist, George Concalves, and his associate Ash Shetty write in a research note, citing the most recent Treasury International Capital data. In April, overseas investors sold about $5 billion of Treasuries; Europe and Asia liquidated $45 billion, with China accounting for $6.8 billion.
Over the past 12 months, TIC data show overseas investors bought a net $80 billion, with $211.6 billion being bought by investors in the United Kingdom, the domicile of many hedge funds and other global investors. China actually was a net buyer, but just a modest one, with $36.9 billion.
While so much attention is focused on foreign purchases of Treasuries, the big action has been in U.S. agencies, most of which consist of mortgage-backed securities from government-sponsored Ginnie Mae, Fannie Mae, and Freddie Mac. In April, overseas investors bought $20 billion of agencies, bringing their 12-month total to $186 billion, or over $100 billion more than Treasuries. Asia accounted for $160 billion of those purchases, including $24 billion from China.
U.S. corporations also get key support for their borrowing habit from abroad. Foreign investors bought $128 billion of corporate bonds in the latest 12 months, although just $1.6 billion in April. As for equities, overseas investors bought $82 billion ($6 billion in the latest month).
The numbers show that, even more than Uncle Sam, U.S. home borrowers depend on the kindness of strangers. China could retreat from bolstering the American housing market merely not reinvesting the monthly MBS interest and principal payments, resulting in a stealth tightening of mortgage credit.
The housing market is already in the doldrums, as May’s weaker-than-expected existing home sales at an annual rate of 5.43 million, 100,000 less than forecast and below April’s 5.45 million annual pace. That disappointing home sales pace comes with unemployment at just 3.8%. But with single-family home prices up 5.2% from a year ago, home sales are sluggish. A further push up in mortgage rates, already at seven-year highs, would further crimp this key sector of the U.S. economy.
If the tariff wars escalate, U.S. interest rates could rise if foreign investors decide for whatever reason to sell securities, which would slow the economy. In the process, the tariffs could accomplish their goal of shrinking the trade deficit. That would come about by reducing consumer spending and boosting savings—which is what a recession does.
Even after Tuesday’s sharp selloff in global equity markets, the sentiment voiced by many investors continues to be that the tariff threats remain bluster. The message of those losses is that tariffs may not only pose a threat to global trade but also to flows of capital.