The Ace up China’s Sleeve
When it comes to the United States, the country has been known for many things. Right now it’s being talked about mostly for its part in the trade war, but before there was a trade war there was debt. And lots of it.
The United States is over 16 trillion dollars in debt and the number is steeply climbing. We’re not even halfway through the year and the deficit has climbed by more than 30% this year alone.
However many people out there don’t really know what the United States deficit even is, or what a deficit means.
Is there an international bank somewhere where the US holds the biggest mortgage in the world?
The debt that the United States owes exists primarily as treasury bonds, just like the kind you might buy as part of your investment portfolio.
When you buy a treasury bond to beef up your index fund, you’re loaning money to the Government – money that the Government will pay you interest for until you sell the bonds and pass the debt to someone else.
The United States runs its budget at a loss, so it sells these bonds to other countries and keeps the money as a loan.
Which country owns the most of these bonds?
Can you guess?
China isn’t the only country that owns United States treasury bonds. Other countries include Brazil, the United Kingdom and Japan to name a few.
But China owns the most.
Right now China’s balance is sitting at around $1.1 trillion.
The United States is counting on China to continue buying up their debt into the future. As the United States continues to run its budget at a loss, it’s only able to do that by knowing that it can rely on China and other countries to absorb the debt. If there was even a moment that they thought China wouldn’t pick up the pieces, the damage could be catastrophic.
The trouble is that China knows that.
Right now the United States isn’t worried that China will stop buying up their debt. The US has a fantastic liquidation record, its bonds are desirable and easy to sell; but best of all the interest rates are historically great.
US bonds are and always have been a great investment, and China is in the business of making great investments.
But investing is peacetime behaviour – and we might be on the precipice of the next cold war.
Cold War 2.0
China not buying United States debt would be bad enough, but selling the bonds in large quantities would be even worse.
Experts argue that this is very unlikely because in the weeks following the sale, China would be as badly affected as the US would.
A sharp decline in the value of the US dollar would hurt Chinese trade and would make imports more expensive, among other problems.
But unlike in the US, Chinese congress and the President are no so worried about public perception.
Communism vs Democracy
The Chinese president no longer has term limits and his power is absolute. A few years of public distress is not a big price to pay when considering unleashing untold damage on your biggest global rival.
The biggest problem they could cause is to the value of the bonds themselves.
They would lose value, while the interest rate they pay would go up.
This means that everyone who already own the bonds around the world would lose a lot of value in their investment. However anyone that doesn’t own any can buy them up for rock bottom prices and get higher interest payments from the US as a reward.
This would trigger a slump in the US economy, affect both consumer and business credit and raise interest in all types of debt. Including mortgages.
One big reason selling US bonds would be bad for China is because of the impact it would have on the Renmingbi (RMB) the currency of China.
Riding the Dollar
The RMB or Yuan isn’t a free floating currency yet. This partially means that the currency is a lot less stable than the US dollar and is therefore a lot harder to use when trading internationally.
To keep international trade strong, China will want to hold onto US treasuries and continue to use them to guarantee their own currency.
However if they unloaded a lot of them to teach Trump a lesson, it’s very likely their remaining stockpile would be worth a lot less as a result.
They stand to hurt themselves too much. This alone is enough to convince experts that it’s too unlikely that this terrible event will ever actually happen.
So the 16 billion dollar question has to be –
is China willing to badly hurt themselves in an effort to obliterate America?
So.. Do you feel lucky? Well do ya?