The US-China trade war is escalating. The Trump administration has put a ban on Chinese tech giant Huawei, causing fresh tensions. As both sides weigh their bargaining chips, some observers have pointed out that China’s nuclear weapon in the trade war is its holdings of over US$1 trillion of US treasury bonds.
Beijing is sitting on a massive pile of US$3 trillion foreign exchange reserve, including around US$1 trillion in US Treasuries, about 20 percent of the US debt held by foreign countries. Beijing reduced some of those assets in late 2016 and early 2017 to help offset an increase in the Chinese yuan, but the holdings are still huge.
Is the US bond holding a powerful weapon or could it turn into a hot potato? China won’t dump the Treasuries unless it has to, since Beijing needs to use the massive foreign exchange reserve to stabilize the exchange rate. Also, there is no other asset that can beat the dollar in terms of credibility, liquidity, and investable projects.
The dollar has become the most powerful weapon of the US in cementing its dominance across the world. No matter how many dollars you own, the US can refuse to settle payments for you if it wants to punish some nation. That’s what happened to Iran and North Korea, as part of sanctions. Several banks that have contacts with countries or people who are not welcomed by the US have caved into Washington, after the nations were cut off access to settling in dollar.
Coming to the Chinese yuan, it has to become a global currency and establish its status as a payment tool for other nations if China wants to get around the US rules. That means China needs to convince other nations about the nation’s credibility, exchange rate, and financial stability. Until then, holding an enormous amount of foreign exchange reserve could be a headache for Beijing.
This article appeared in the Hong Kong Economic Journal on May 24
Translation by Julie Zhu
[Chinese version 中文版]
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