“China’s external sector is still dollar-based. They need dollar reserves,” said Stephen Jen, from Eurizon SLJ Capital.
Chinese corporations have racked up $US840 billion of onshore dollar debt, and probably another $US1 trillion in offshore dollar loans. These include state entities with the implicit (questionable) backing of Beijing.
Mr Jen says the government has guaranteed redemptions in US currency for foreign investors using the Hong Kong-to-Shanghai “Connect” pipeline and the China Interbank Bond Market (CIBM). The country’s global credibility hinges on this.
“People can make threats but China can’t dump US debt,” said Mr Jen.
Chinese reserves are no longer large for an emerging market, though the country has accumulated other sorts of illiquid assets through the Belt and Road Initiative.
Reserves peaked at $US4 trillion in early 2014. They plummeted by $US1 trillion during the currency scare in -2015-16, when capital flight forced the People’s Bank to burn through $US100 billion a month. That was a traumatic episode for Beijing.
Chirag Mirani and Zhao Li, from UBS, said China is gradually diversifying. Its share of US Treasury debt has dropped from 12 per cent to 7 per cent as the US keeps building up debt – now rising at a galloping pace with Donald Trump’s $US1 trillion deficits.
Russia dumped $US80 billion of US debt for political reasons (84 per cent of its holdings) over a two-month period in early 2018. The market did not even notice.
The Fed has sold $US600 billion of bonds as it reverses QE. Yields did not spike. Ten-year Treasuries have instead fallen to a two-year low of 2.38 per cent.
Shrinking liquidity and recession worries have led to a scramble for safe-haven bonds and for deflation hedges. These effects overwhelm all else.
The Chinese “nuclear option” so favoured on WeChat simply does not exist. What might be more interesting is a Chinese blockade of lithium and rare earth minerals needed for hi-tech manufacturing and defence. Beijing has a stranglehold on immediate world supply. US strategic stocks are too low to last a long siege.
Wait for that shoe to drop.