What if China Sells all of its U.S. Treasuries?

Here’s another common one from the Ask Cullen page:

Question: Cullen, what would happen if China dumped all it’s US dollar denominated bonds?”

Answer:  Someone else would own them. :-)

That’s like saying “what if Vanguard dumped all of its XOM shares?” Well, someone else would own them. Vanguard would sell their XOM shares and obtain cash and someone else would get rid of their cash and own (Exxon) XOM shares.

Vanguard owns about 5% of all outstanding XOM shares so it’s a huge amount. And if they were a forced liquidator or worried liquidator then it could put some pressure on prices. But it wouldn’t change the fundamentals of XOM. And so any major price deviations would be largely unwarranted.

If China decided to unload their holdings of U.S. Treasuries in a low inflation environment then my guess is that savvy bond traders would gladly scoop them up and exchange their paper dollars for something that generates a real return.  China would be left holding a bunch of dead presidents that just sit their collecting dust and losing purchasing power.  So what?

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. Cullen, I just wanted to thank you for the new Ask Cullen site. Your commitment to educating the public does not go unnoticed. Thanks so much for your efforts. I don’t know what keeps you going!

  2. “The Chinese are holding a loaded water pistol to our heads”

    I believe they own about 10% of the publicly held sovereign debt. And if they sold it then they would just end up buying other US dollar denominated assets – so what’s the difference? It’s not as if they can foreclose on the USA. Its dismaying to see our leaders trot out the tired memes to agitate the voters. How many times did Romney/Ryan try to scare us with the notion that Obama’s policies would have us borrow more from China to do this or that?

    Fear is the politician’s best ally.

  3. But that assumes that rates won’t go up and making those bonds worth less. In a REAL (hardcore) deflation rates WILL go up. That’s still up ahead. Then I prefer to hold a bunch of dead US presidents instead.

    Remember “Operation Twist” ? The FED bought 30 year T-bonds and sold short term T-notes. It was – IMO – meant to absorb (among others) the chinese supply of long term T-bonds. Because long term rates went nowhere.

  4. Usually, when someone asks that question, they really mean “what happens if they sell tsys and buys X” (X is typically, MBS, stocks (generally), CRE, infrastructure, US international brands, tech companies). We should be careful that China is like everyone else, portfolio rebalancing can shake things up.

  5. This is way too simple. China would receive dollars, convert those dollars to Renminbi. The Ren would strengthen and the dollar would weaken. Inflation would rise here and fall in China. Higher inflation would mean lower real yields FURTHER pushing down the price of TSY’s. Higher yields would kill any recovery and send us into recession. Recession = less jobs, lower asset prices blah blah blah.

    Your high level analysis has reached zen levels where nothing really matters. Congrats. We can be best friends! Please feel free to buy from me at high prices and I’ll buy from you at low prices.

    • You’re overcomplicating and abusing the quantity theory of money. There is no mathematical law stating that more money means more inflation or more money means higher yields. You’re just assuming that. But there are many more variables in the inflation equation than that. Yes, I am not calculating or estimating inflation in this post. I am ASSUMING that we remain in a low inflation environment. Obviously, if inflation did rise (for whatever reason) then it would be less beneficial for some people to hold US Treasuries though not necessarily less beneficial than holding cash.

      No zen levels. Just complex subjects being dumbed down so that people can understand them. That’s all.

      • Okay. I’ll concede ceterus paribus, but that’s what the free market enterprise is based off of. But things don’t stay constant and their is opportunity and opportunity sets are about.

  6. Replace above ^ with below.

    Okay. I’ll concede ceterus paribus, but that isn’t what the free market enterprise is based off of. Things don’t stay constant and that is what opportunity and opportunity sets are about.

    • Bahhh. I never loved Disqus, but it’s probably an improvement over the default comment section in this site. Big problem though – it appears to have deleted all of the old comments.

        • I won’t use discus, facebook, twitter or any of the other social media mediators for comments.
          I do not think people should be forced to create yet more online
          accounts. I do not think blogs should compel readers to use and support
          companies they would not choose on their own.

          • You don’t have to login through Disqus here. I left the guest option open specifically to avoid that. This comment system is has all the same features of the original one plus more. What do you not like about it?

            Thanks for the feedback!

  7. Pettis explains this beatifully. It might take some googling, but it is out there. Cullen, I am a bit surprised that decided to make a post out of your answer. There are obvious implications if Chinese, European, Japanese, other EM, or Americans end up buying these assets. Also, what does China buy instead, if anything at all? These options all have interesting international accounts ramifications.

  8. 1. the yuan would appreciate against the USD, thus killing their exports. But chinese (price) inflation would be lower.
    2. the US Current Account Deficit would shrink and the US would be forced to live less beyond its means. And it would push US interest rates higher.

    • China could always print and spend enough Yuan to keep the value from going up compared to the dollar. Imagine they just kept printing Yuan and buying dollars, and then allocated the dollars equally into 4 things, S&P 500, oil , gold, and dollars. They could keep doing this until the Yuan was as low as they wanted. It would either work and they would stop or they would end up owning all the S&P500, oil, gold, and lots of dollars. Selling Treasuries does not necessarily mean the Yuan must go up.

      • - The Yuan would go up when China sells Treasuries. Because selling Treasuries means China sees an net inflow of money and that pushes the yuan higher.
        - If China would get rid of capital controls then it would see an outflow of money and would push the yuan lower. But that would cause more chinese credit deflation.
        - China can (literally) print as much yuan as they want. But that wouild push the yuan lower but that will create massive price inflation and will lead to massive civil unrest.
        - China can sell its Treasuries but that would push US interest rates higher, thereby killing their most important export market.
        - Buying the S&P 500, oil, gold simply means selling USD, not buying USD.
        So, no matter how you slice it, no matter what China chooses, it will all be detrimental to China. But don’t be fooled, what ever China chooses it will be detrimental for the US as well. In that regard the US and China are in the same boat.

        • If China sold all its treasuries but held the proceeds in cash USD instead this would not affect the value of the yuan, no?

  9. The only way the US Treasury is currently able to unload around $1 trillion in bonds each year is that the Fed is making new money and buying about $1 trillion in bonds. If the Chinese tried to dump their $1 trillion in bonds then either the Fed would have to buy $2 trillion in bonds or the price of bonds would crash. Or both.

    • Vincent, how do you know that “the only way the US Treasury is currently able to unload $1 trillion bonds each year” is through QE? That is a very strong statement with no proof to support it.

      • Bernanke hinted that he might start tapering down the monthly QE and interest rates have about doubled since then even though he backpeddled on that hint as fast as he could.

        If the Fed were not buying like crazy then the USA would be like Greece. Interest rates would be far higher and the government would be clearly bankrupt as the interest alone would clearly be unsustainable.

        • Haha, I assume the only reason you would compare the USA to Greece on this site is if you were trying to provoke a reaction from other posters. :)

          • :-) Ya, I have been around long enough to know that this should provoke a reaction. But I don’t think I am trolling or just trying to cause trouble. I do think it is an interesting point.

        • dont think we would be like Greece. other than being 2 countries there is very little in common. Greece shares a currency with several other nations. not all of whom look like they do. The US has its own currency. so we control our currency, they can’t. and among other things, our is the world reserve currency, and lots of commodities are priced in it (especially oil). and so far none of the oil producing countries really wants to change that (though Iran tried to change to the Euro. wonder how that worked out for them). and not sure that rates would rise that much. cause lets have a reality check here. what other currency could be the world’s reservce? it wont be the Euro (after all that is Greece’s currency). and it wont be Yuan,very few countries will accept it in exchange for goods etc when the world’s economy tried to collapse back in 2008, all the money flowed to the US.

          • Imagine Bernanke were replaced by Ron Paul and there would be no more QE at all. Then the US would be like Greece for all practical purposes. Now I know that Obama is not going to put Ron Paul in charge of the Fed, so this is just a theoretical exercise. What makes the US different from Greece is that it can print its own money and it does in large amounts.

              • Imagine Ron Paul was head of the Fed and has been very clear his whole life that he is against monetizing debt, Fed buying government bonds, printing money, making new money, QE, or anything similar. So even though there was the theoretical possibility that the USA could make money it was in practice not going to happen. In this hypothetical situation (never going to happen in the real world) then the USA would in practice be in the same situation as Greece, not able to make new money.

                • You seem to think there would be no one to buy the bonds if the Fed wasn’t there to do it. That’s obviously not right. Many people, including Bill Gross said this when QE2 was set to end and demand for Tsy bonds remained extremely strong after the program ended.

                  Ron Paul might eliminate some of the crazy Fed policies, but he wouldn’t eliminate govt spending. That’s Congresses role. Not the Fed. You’re confusing monetary policy and fiscal policy.

                  • The difference between Greece and the USA is that the USA has the Fed to buy bonds with new money. If the Fed were not buying bonds, and the laws were not changed to allow the Treasury to just print and spend money, how would the US not be like Greece? Why is it “obviously not right”? If no private parties want to buy Greek bonds and they can not print money they are in trouble. If no private parties wanted to buy US bonds and they could not print money, they would be in trouble. Where am I going wrong? If the Fed was not backstopping the bond market, why would people feel safe in buying US bonds? Why would it not be Greece?

                    • Now you’re saying something different. If not private parties wanted to buy US govt bonds then we’d have a different situation on our hands. The reason why no one wants to own Greek bonds is because there are Euro denominated options that are much safer (like Bunds or really any of them). If you live in the USA and you use USDs and you want to earn interest risk free then you have one choice – US govt issued securities. Rates on US govt bonds will fluctuate, but not because there is no one that wants to own them, but because expectations of their real return will change. Totally different than in Greece where the country can run out of money AND there are Euro denominated superior options that much more closely reflect something risk free. In Greece it’s about solvency. In the USA it’s about inflation.

                    • The federal deficit finances itself by what it is – a net outflow to the other sectors of the economy. That net flow, then flows back into bonds purchases. In other words, the deficits come first, then the bond purchases are funded by that net flow.

                      Instead if the private sector was the one with the deficit (net negative savings), then the government would have surplus, which over time would reduce outstanding bonds. It would the be the reverse of the first paragraph above.

                      In both flows, it starts with government spending, the issuance of debt does not come first – it comes after and is part of the flow.

                      That is the system, and the important point: The government’s spending is the first step of base money creation. The debt issuance come later, as a simple part of the flow, and it all ends with taxes, which destroy base money. In other words, the US government is not revenue constrained.

                      Greece on the other hand has the opposite direction in fiscal matters, it must acquire Euro first to spend it, and must issue bonds first or tax first in order to do that. It is revenue constrained.

                    • That’s actually not exactly accurate. Most of the money issued in our system is issued as inside money or bank money. That money is what the govt obtains to spend. It does not spend its own money. It is not a self financing entity. You’re using the MMT framework, which I don’t think is quite right.

                      When the govt spends it obtains a bank deposit, issues a t-bond and redistributes the bank deposit. The spending does not come from the govt “first”. It came from the bank issuing a loan first which created a deposit which is redistributed when the govt taxes us.

                      That said, the govt is a contingent currency issuer so it is never at risk of “running out of money”, but our specific design is not one where the govt “spends first” and “taxes second”. In most cases, the banks issue loans first and the govt taxes our deposits.

                    • I do not understand the inside money argument. It seems that increases demand, but is not base money, as it is horizontal with not net increase (equal debt and liability created.) Based on things such as Sectoral Balance, your recent chart corporate profits as a % of GDP, it seems the driving funding source is government spending, no? If not, please explain why not in context of the Sectoral Balance and that recent chart please.

                      And is the only thing to increase net financial assets over the long term, no? ALso if not, why not in context of those charts?

                    • Most of the money in our system starts with inside money. Inside money is bank money or deposits that were created by loans. When you look at the flow of funds through our system you cannot logically start with govt spending as MMT does because that’s not how it actually works in most cases. The flow starts with private banks creating inside money as deposits. If the govt wants to spend it does not simply credit its own account and spend NEW deposits into the system. In the case of taxation it simply takes your deposit and redistributes it through the system to someone else. MMT tries to claim that the Reserve System results in the “destruction” and “creation” of money to create the view that the govt is the creator of the money. The reality is that there is a specific flow of funds in our system that starts and ends with banks. Loans create deposits and when the govt wants to spend it obtains deposits and redistributes them. The only way that deposit can be destroyed is if it makes its full life cycle back to the bank in loan repayment.

                      As for the corporate profits chart – that is simply showing how private investment has been weak so the govt’s spending has picked up the slack. It’s better to think of a govt deficit as a flow of funds PLUS the issuance of a NFA (the t-bond) as opposed to the creation of new money.

                  • It may be easier to think about Japan. Has any country that could not print its own money every gotten close to the debt level of Japan? I don’t think so. It is the central bank monetizing so fast that the money supply is increasing by 1% every 10 days that makes them not Greece.

    • The Treasury is able to “unload” bonds because the Chinese have an excess of USD currency that pays no interest. That comes from a currency account surplus (that would be China with he surplus, BTW). They look at all that USD and decide “hmmm, maybe we should think about a risk free return”. Voila, US treasuries are purchased.

      if they want to convert that to interest free USD, the Treasury would be more than willing to accommodate.