The recent intensification of President Donald Trump’s hard line on China has included a wide-ranging grab bag of policies and proposals that touch on everything from student visas to soybean purchases. But the most explosive might be the suggestion floated by some right-wing lawmakers and commentators that the country could choose to default on some of the nearly $1.1 trillion in U.S. Treasury bonds held by China.
The proposal alarms analysts, who say even entertaining the idea is dangerous in an economic environment characterized by a pandemic-driven recession and a massive increase in the national debt.
Sen. Lindsey Graham, R-S.C., a close Trump ally, said on Fox News, “They should be paying us, not us paying China,” and expressed support for a suggestion from Sen. Marsha Blackburn, R-Tenn., that the U.S. should cancel its sovereign debt held by China.
John Yoo, a law professor at the University of California, Berkeley, and visiting scholar at the American Enterprise Institute, said in an article that the U.S. could “make China pay for COVID-19” by reneging on its commitment to bondholders. “Conceivably, Washington could even cancel Chinese-held treasury debt and us[e] the proceeds to create a trust fund that would compensate Americans harmed by the pandemic,” he wrote.
While Yoo allowed that this would roil financial markets, others say even that acknowledgement vastly understates the scope of economic calamity this would trigger.
"The challenge behind this concept is it pushes up interest rates and pushes down the dollar, and would cause significant turmoil in markets.”
“We are the largest debt market in the world when it comes to sovereign debt, and the dollar is generally considered the world’s reserve currency. The challenge behind this concept is it pushes up interest rates and pushes down the dollar and, in general, would cause some significant turmoil in markets,” said Rob Haworth, senior investment strategist at U.S. Bank Wealth Management.
“My concern is if we keep amping up the rhetoric, it's going to result in something that’s even worse for the economy,” said Jamie Cox, managing partner at Harris Financial Group. “We've already got enough bad stuff going on in the economy. We don't need another thing on top of it,” he said.
“One of the great advantages America has is we have the cheapest cost of borrowing anywhere on the planet. And the key reason why is we pay our debts, and that’s been a boon to the American taxpayer and the economy,” said Mark Zandi, chief economist at Moody’s Analytics.
If the U.S. deliberately walked away from these obligations, that advantage would vanish. “It will mean that all investors will price in the possibility that the American government gets mad at them for whatever reason… and you don’t get your bonds paid,” Zandi said. “They’re going to demand a much higher interest rate for taking that risk.”
Jacob Kirkegaard, senior fellow at the Peterson Institute for International Economics, suggested that the increasingly bellicose tone was politically motivated.
“The big picture is this is an integral part of the reelection campaign,” he said, adding that Trump is capitalizing on the growing anti-China sentiment seen in recent polls. “It’s one of the few areas where the American public is increasingly unified,” he said.
“No one’s happy with the way the Chinese have behaved in trade and international relations, but this strategy this administration has pursued, three years in… it’s not working. It’s unraveling,” Zandi said.
As a practical matter, selectively defaulting on Chinese-held Treasuries might not even be possible to execute. “It might not be as easy as it sounds to identify whether the Chinese government owns the bonds. It might not be that straightforward or even impossible,” Zandi said.
It also would throw the entire U.S. financial system into disarray. “U.S. Treasury debt is thought of as risk-free in our own regulatory framework,” Haworth said.
Experts say even if the White House never pursues this further, raising it as a possibility could prompt investors to reevaluate Treasuries as the world’s benchmark safe haven. China is a principal buyer of Treasuries, so if the country significantly scaled back its purchases, or sold a material amount of its existing holdings, the associated slump in demand could drive up America’s borrowing costs.
White House chief economic adviser Larry Kudlow asserted in a recent Fox Business interview that he didn’t expect China to sell U.S. debt because he said doing so “would bankrupt the Chinese government,” he said. But China pared its holdings of long-term Treasuries by roughly $36 billion in the first three months of 2020.
“I think they’re already becoming more cautious in their buying,” Zandi said. “If the Chinese take it seriously, then they're going to be more cautious buyers" — which could drive borrowing rates higher and make it more expensive for the Treasury Department to pay off its massive debt.