China Won't Sell Treasuries to Hurt Trump
(Bloomberg View) -- Many of the proposals or suggestions on how China might respond to U.S. tariffs have the air of "Surrender or I will shoot myself in the foot." They may not only hurt China, but damage the country's campaign to establish itself as a financial power and hinder the use of the yuan as a reserve currency.
It's possible China will use talk of such steps to make the Trump administration more flexible, but very unlikely Beijing can follow through.
The proposals that have been put forward include:
- Depreciate the yuan.
- Sell U.S. Treasuries.
- Sell U.S. equities.
- Place tariffs on U.S. oil exports along with soybeans.
- Hinder exports of U.S. services.
- Offset U.S. tariffs with subsidies to Chinese exporters.
Some of these would be difficult to accomplish simultaneously, pushing in opposite directions. The temptation to fight in financial markets is there. Chinese goods exports to the U.S. are about 4.25 percent of gross domestic product while U.S. exports to China about 0.65 percent of American GDP. It sounds plausible that China would threaten to retaliate in financial markets, but the threat is less convincing when China itself would be severely affected.
The key problem is that these financial measures do as much damage to China as to the U.S., and several of them do tremendous damage to China's neighbors and emerging-market countries that Beijing is courting in making the yuan an international currency.
The last time China depreciated its currency significantly, in August 2015, it set off a sequence of cascading declines in emerging markets and a rise in asset volatility. That was set off by a mere 2 percent yuan depreciation. Depreciation would have to be much greater to have an impact on trade. Enlarging the range of countries and asset markets that are affected by a bilateral trade dispute will earn China strong criticism from countries that might otherwise by partners.
Similarly, selling U.S. Treasuries is a problem both for China and emerging markets. U.S. Treasury yields tend to lead Chinese yields as shown in the first chart below. The co-movements are not identical, but they are close enough to be very significant. Moreover, an increase in U.S. yields would spill over globally. The People's Bank of China could change domestic policy to offset this, but that would not insulate the rest of the emerging markets and even the developed world. China will get neither sympathy nor thanks for pushing global interest rates higher.
Nor is the Chinese stock market insulated from Wall Street. The two have moved largely together since trade began to top the agenda, as the second chart below demonstrates. If you are going to tank U.S. equities, it's hard to avoid tanking your own and your neighbor's.
The currency implications are uncertain. Selling U.S. Treasuries and buying European bonds or Japanese assets will probably weaken the dollar, putting downward pressure on China's own currency. Emerging-market currencies would likely follow suit and decline against both the euro and yen. If China went so far as to boycott U.S. Treasury auctions, even just for symbolism, the dollar would fall sharply even as U.S. yields climbed. America's trade deficit still needs to be funded and the greenback would slide until funding emerged.
Hindering U.S. exports of petroleum or services would be a nuisance, but oil is pretty fungible. The announcement would affect West Texas Intermediate, the type of oil produced, refined and consumed in North America. But the impact will likely be arbitraged away relatively quickly as China bought from other markets. Some U.S. oil would probably end up re-exported from third countries. America has a trade surplus in services, but it's relatively small compared with the goods trade deficit. Much of the services surplus is in travel and intellectual property, areas where interference would be unpopular or damaging.
Chinese government reimbursement to its exporters for additional tariffs is the most benign move Beijing could make. Some of the reimbursement might be financed by tariffs that China collected on U.S. firms. This would have the least impact on bilateral trade, and minimal spillover internationally and in asset markets. It could become a fiscal issue in China (and the U.S., in the event Washington did the same), but might serve to remind that the stakes are lower than the rhetoric.
Bottom line, it's more likely that China will threaten retaliation through financial markets than actually carry it out. Were China to act on the threats, the country might do more damage to its aspirations to an international yuan than any plausible gain that would emerge.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Steven Englander is the head of research and strategy at Rafiki Capital. He was previously the head of G10 currency strategy at Citigroup and the chief U.S. currency strategist at Barclays.
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