“America first” – or not? US President Donald Trump sees the US as the only remaining superpower – and regularly railing against China’s supposedly unfair and aggressive economic policies. Trump has trumpeted the Middle Kingdom’s economic policy struggle – and ignored the fact that China has been the biggest creditor and most important financier in the US for years.
It is fundamentally tricky to threaten his financier – and all the more so because Trump will drive the debt of the United States by its tax reform to new heights. With the immense debt burden, the US dependency on its backers is growing, and China Trump has now felt that.
On Wednesday, a mere rumor from Beijing showed how dependent the US is on China. According to insiders, the biggest creditor in the US threatens to turn away from his main debtor as a financier.
Representatives of the Chinese leadership have recommended that purchases of US government securities be reduced or even stopped, the Bloomberg news agency reported with reference to persons familiar with the matter. The recommendation also has to do with the trade tensions with the US.
Dollar collapses, yields on US bonds skyrocket
Although it is unclear who exactly gave the advice, let alone whether it will actually be implemented, the reactions in the financial markets were strong. The US dollar weakened significantly and drove the euro higher. The yield on 10-year US government bonds climbed to its highest level since March 2017. A higher return on free trade tends to make borrowing more expensive for each country – not good news for the White House.
The fact that even a rumor can trigger such violent reactions is due to the enormous importance that China has as a creditor of the USA. With its gigantic foreign exchange reserves, the Chinese finance to a considerable extent the lives of Americans on the pump.
Life on Pump: The US owe China $ 1.2 trillion
According to the latest US Treasury Department figures, Chinese creditors hold close to $ 1.2 trillion in US government bonds and other US securities. No other country in the world can do more.
The enormous sum has accumulated over decades, because China permanently exports more to the US than imports it from there. Most of the revenue from exports is invested by the Chinese in the US, because the investment there is considered safe and the dollar is regarded as a stable world-leading currency.
Are the Chinese now considering exploiting their power as creditors to put pressure on the US? The rumor from Wednesday could be interpreted in this direction. But there are also purely rational reasons for the Chinese to be careful. In the eyes of the Chinese officials, the US papers have simply lost their appeal, according to the Bloomberg report.
Significant expansion of US government debt
Right now, two factors threaten to put pressure on the US bond market. On the one hand, the US is heading for a significant expansion of public debt, above all because of Trump’s tax reform. This would increase the supply of US securities and thereby tend to lower their value. On the other hand, the US Federal Reserve has been gradually reducing the gigantic mountain of US bonds that it had amassed for years to mitigate the effects of the crisis. As a result, she also provides for an additional offer. All this could raise interest rates on US government securities, which would reduce the value of existing securities.
Should the Chinese actually turn away due to the fear of a depreciation of US bonds, there would be the danger of a self-fulfilling prophecy or even a downward spiral, because even more US creditors would be affected and could jump off. This is one of the reasons why even the slightest rumor in the financial markets is taken seriously. If China gets serious, it could boost US yields significantly, warns Craig Erlam, financial services firm expert Oanda.