Why China won’t drop the atomic bomb of dumping US Treasuries
A top Chinese think tank voices concern over potential US debt crisis.
In this brief:
China’s vast holdings of US Treasuries are considered a potential financial “weapon of mass destruction” that Beijing could use to roil US debt markets and undermine the status of the greenback, in retaliation for an escalating trade war with Trump.
Top economic thought leaders in China appear more concerned, however, with preserving the value of the country’s huge trove of foreign reserves.
Xu Qiyuan (徐奇渊) from the Chinese Academy of Social Sciences has voiced concern that the US could succumb to a debt crisis as result of unrestrained deficit spending since the Covid pandemic.
Xu further argues that US Treasuries are fast shedding their status as the world’s leading safe haven asset, due to Washington’s recent ceding of international credibility as well as emerging dysfunctions in American debt markets.
As the economic Cold War between China and the US intensifies in the wake of Trump’s Liberation Day tariff measures, Western pundits point to Beijing’s tremendous holdings of US Treasuries as one of the most potent tools in its policy arsenal.
Beijing lays claim to a vast trove of US debt, acquired via the trade surplus it’s run up with America that serves as the very pretext for Trump’s imposition of punitive tariffs.
While Beijing trimmed these holdings in recent years due to concerns over mounting tensions with Washington, China still remains the USA’s second largest foreign creditor after Japan, with an estimated $760 billion in its Treasury securities
These holdings give China the ability to cause turmoil for the US Treasury market by dumping them en masse. Reducing the price of these nominally risk-free securities would in turn have the effect of raising the USA’s long-term interest rates.
This could inflict tremendous pain on the American economy, by increasing the cost of borrowing for both government authorities and corporate concerns, potentially even contributing to a fiscal crisis.
Bloomberg estimates that the US Treasury will issue around $2 trillion in new debt this year, as well as roll over $8 trillion in maturing bonds. Every percentage point rise in the yield on Treasuries could cost the US government approximately $100 billion.
Disturbances in the American debt market would also have the devastating effect of undermining the status of US Treasuries as a safe-haven asset, and the long-standing dominance of the greenback as the global reserve currency.
China concerned more with foreign reserves than financial war
Many pundits have expressed concern over the possibility of Beijing wreaking havoc on US debt markets by dumping Treasuries, should the trade war with Trump further escalate.
China’s top economic thought leaders appear far more preoccupied, however, with preserving the value of the country’s foreign reserves, which would take a major hit as a direct consequence of any decline in Treasury values or the US dollar.
While outside observers may point to China’s huge US Treasury holdings as a potential weapon of financial destruction, they’re also a double-edged sword that creates vulnerability to US policy decisions just as much as they confer influence.
This has long been a source of concern for China’s leadership, ever since the country’s emergence as a global export power led it to amass huge sums of US debt.
In March 2009, Premier Wen Jiabao expressed concerns over China’s then $1 trillion holdings of US Treasuries, and impact on its value of the huge stimulus plan launched by the Obama administration to abet recovery from the Global Financial Crisis (GFC).
While Beijing could now cause turmoil in debt markets by dumping some of its US Treasuries, this would be an act mutually assured destruction that would undermine value of its remaining dollar assets, while also causing a surge in the yuan that could undermine Chinese exports already hampered by Trump’s shock tariffs.
Top Chinese think tank warns of potential US debt crisis
The peril associated with being America’s second biggest creditor has prompted leading economists in China to urge a reconsideration of the country’s vast holdings of US Treasuries.
One such clarion call hails from one of China’s most prestigious and influential state-backed think tanks.
Xu Qiyuan (徐奇渊), a researcher at the World Economy and Political Research Institute of the Chinese Academy of Social Sciences (CASS) warns of the heightened risks associated with Beijing’s copious US Treasury holdings since Trump’s assumption of office.
“US debt markets currently face unprecedented challenges…the future of US debt is full of uncertainty,” Xu wrote in an opinion piece entitled “China Should Focus on the Potential Risk Faced by US Debt” (徐奇渊：中国应关注美债面临的潜在风险).
“The problem of the debt ceiling has reemerged, DOGE under the leadership of Elon Musk has painfully retrenched staff and cut costs, and the Mar-a-Lago Accord has raised the possibility of the US covertly defaulting on government debt.
“These developments all create uncertainty for markets.
“For China - in its dual role as a major creditor of the US and a potential supplier of secure renminbi denominated assets, greater attention should be given to the future of US debt. “
A key cause of anxiety for Xu is one shared by deficit hawks on the conservative side of politics in the US - the rapid accumulation of debt by Washington, spurred by what many deem to be needless and irresponsible fiscal expenditures.
“The USA’s prior build up of government debt and its fiscal policy decisions are inseparable,” Xu writes.
“During economic downturns, the government should expand expenditures to support the economy, and during economic expansion, it should undertake fiscal reorganisation.
“However, ever since the Covid pandemic, US fiscal expenditures have readily loosened yet been hard to rein in, leading to sustained, large-scale accommodation.”
Xu points out that US Federal government expenditures have remained above the $6 trillion level in every financial year from the 2020 - 2024, rising to $6.8 trillion in 2024.
He also points to the possibility that deficit spending could further increase during Trump’s second term in office, given the penchant for fiscal expansion displayed during his first term.
While Treasury Secretary Scott Bessent has called for reducing the deficit to 3% by 2028, Xu notes that the Congressional Budget Office forecasts that the US deficit will be 5.2% - 6.2% from 2005 - 2028 - at the very least two percentage points higher than the target.
He believes this could lead to a debt crisis that would have dire ramifications for the value of China’s dollar assets.
“The possibility of a US debt crisis is heightened by multiple measures in (Trump’s) second-term, triggering a new round of anxiety over the sustainability of US debt,” Xu writes.
Waning US prestige seen as weakening global appeal of Treasuries
In a piquant irony resulting from the simultaneous influence and vulnerability created by China’s huge treasury holdings, Xu also shares the concerns of hawkish US policymakers with regard to Washington’s dependence upon foreign creditors.
“The US foreign debt situation has continually worsened ever since the Sub-prime Crisis,” he writes.
“In 2023, US net foreign debt hit $20 trillion, comprising 70% of GDP, for a 10-fold increase in volume since 2006 and a 4.3-fold increase as a share of economic output.”
Xu argues that dependence on foreign creditors could spell fiscal peril for the US should it see further weakening of its perceived trustworthiness internationally.
He argues that such a development has already taken place due to the “marked decline in the national morality of the USA.”
“At the time of the founding of the USA, Treasury Secretary Alexander Hamilton was an advocate of never defaulting, even if it were adversaries who held US debt,” Xu points out.
“The confidence provided by the government ensured the maximisation of the liquidity of US debt, given that security and liquidity are mutually reinforcing.”
Circumstances may have shifted considerably since then, however, with Xu painting Washington as an abuser of its hegemonic status when in the role of debtor to other nations.
“In recent years the US has used financial sanctions and the freezing of Russian foreign reserve assets, while members of congress have threatened China’s holdings of Treasuries, and the Mar-a-Lago Accord has proposed the conversion of Treasuries into 100-year interest-free government debt.
“This conduct exacerbates concerns of the market and investors over the safety of US debt.”
He argues that Trump’s tariff war as well as his recent geopolitical decisions are further compounding the negative effects of a long-running series of policy errors that have undermined US credibility, and thus the appeal of its debt as a safe-haven asset.
“The status of the US dollar is significantly dependent upon US military power and its role as a provider of global public goods,” Xu writes.
“The USA’s withdrawal from the Paris Accord and the World Health Organisation, its disregard for international organisations like the WTO and the UN, as well as its huge reduction in international development aid, is undermining its image as a global provider of public goods.”
Dysfunction on US debt markets
Xu argues that other dysfunctions in US debt markets now render it much less appealing for global investors.
He points to a marked decline in liquidity on US Treasury markets that had already arisen several years previously - an issue that he imputes to the imbalance between supply and demand created by excessive deficit spending.
“US fiscal expansion has brought about a rapid increase in the supply of Treasuries, but on the demand side there has not been a corresponding expansion, leading to a decline in market depth.”
Xu also expresses concern over the volatility of the US Treasury market, resulting from pivotal shifts in key market participants.
“In the past ten years, US debt markets have seen a marked structural change in investors,” he writes, pointing in particular to the rising role of retail investors and mutual funds.
They account for market shares of 10.3% and 19.3% respectively, for ten percentage point gains on both counts compared to a decade previously.
Xu also highlights the presence of high-velocity traders and hedge funds as key “shadow dealers” on the US debt markets, despite suffering from weak capital foundations and limited ability to bear risk.
By contrast, the role of more stalwart investors - such as foreign monetary authorities, insurance companies and pension funds, has witnessed a corresponding decline.
Xu considers these structural changes to be the reason for the continually high level of volatility as measured by the ICE BofAML MOVE Index, ever since the loosening of US fiscal policy in the wake of the Covid pandemic.
US Treasuries seen as shedding their safe haven status
According to Xu, all these factors are collectively contributing to the ongoing erosion of the status of US Treasuries as global safe haven assets.
“In the past, US Treasuries have always been considered the most important secure assets internationally,” he writes.
“However, in recent years the status of US Treasuries as a secure asset has shifted.”
In Xu’s view this change is embodied by “flash collapses” in US Treasury markets in March 2020 - just following the start of the Covid pandemic, as well as in the wake of the Silicon Valley Bank collapse in 2023.
Comparison with the US bond market’s performance during the 2008 Global Financial Crisis (GFC) is instructive, given that Treasury markets did not suffer from any such liquidity freezes or breakdowns of functionality during that period.
“When financial markets come under pressure, Treasuries, as a secure asset, should see their yields go down and debt prices rise,” Xu writes.
“However, what happened in reality [in 2020 and 2023] was that yields increased and debt prices fell.”
Should Xu’s views hold sway amongst Beijing’s policymakers, then Washington likely has little need to fear that China will dump US Treasuries as a retaliatory action against Trump’s tariffs, given acute awareness of mutually destructive outcome of such a decision.
The US could expect, however, China to pursue further diversification away from its debt into other assets less susceptible to political risk, as part of efforts preserve the value of Beijing’s foreign reserves and further insulate it from Washington’s policy decisions.