If they decide to unleash this weapon, the US could face severe repercussions.
There is one weapon that China should refrain from using in the escalating trade war with the US. One that could have significant blowback not just on the US market but also their domestic market.
The doomsday scenario is when China decides to start selling Treasuries which is what they currently use to benchmark their currency the yuan. Kit Juckes, strategist at Societe Generale says that would be the ultimate weaponization, after China shocked financial markets on Monday by devaluing the yuan.
Trading blows
This devaluation came on the heels of Donald Trump announcing 10% tariffs on $300 billion worth of Chinese goods on September 1. The US Treasury Department also labeled China as a currency manipulator.
In some circles on Wall Street, China’s currency manipulation was labeled a weaponization. As they are currently the largest holder of US debt at $1.1 trillion, any amount of dumping could send US interest rates through the roof. Putting it simply, the higher the supply of Treasuries on the market, prices go down, yields go up.
As a result. the higher interest rates would naturally raise borrowing costs for the US and negatively impact its investment grade credit rating.
On the flip side, China would probably see a flight of capital out of its domestic markets, leading to higher borrowing costs and a credit rating downgrade as well. All in all, it would be a no-win scenario for all parties involved.
Unlikely Moves
Juckes mentions that headlines involving China’s US Treasury pile are inevitable, but it is most likely that they would stay with it’s current Treasury holdings. Two reasons support this theory, one being that China has nowhere to put the cash it raises by selling US debt.
The other reason is that it would not be in China’s best interest to create global market instability at a time when it is trying to be taken more seriously by the rest of the world.
Possible Solutions
As the US-China trade war escalates to a currency war, the US Treasury’s next step is to enter negotiations, either directly with China or indirectly through the International Monetary Fund (IMF). Senior China Economist Julian Evans-Pritchard theorizes that China is unlikely to come to the table to engage with the IMF, which will probably lead to US-China relations souring even further.
What will probably end up happening is Trump placing more and more tariffs on Chinese imports, and China retaliating with more currency depreciation. It’s unlikely that a solution will arise anytime soon.
