As US/China relations remain troubled, we are increasingly asked if China might seek to punish the US by liquidating its portfolio of US Treasuries, a course of action often referred to as the “Nuclear Option.” Given that China is the largest foreign holder of US Treasury debt (see below), it is a reasonable question and concern.

While no one outside the circle of senior Chinese government officials can predict the country’s course of action, we don’t see China exiting our bond market en masse for a few reason:

  • Any such move would create meaningful financial instability, likely damaging the Chinese economy more than ours.
  • The US bond market is the world’s largest, most liquid and, importantly, pays a positive yield; a transition from US to German or Japanese debt is an unattractive option.
  • Selling US debt should drive any remaining Chinese holdings down in value and push the US dollar lower versus the Chinese Renminbi, making Chinese exports more expensive and less competitive.

We think it is important to put the US/China debt dynamic in perspective. There is about $21 trillion of US debt outstanding, and while China is the largest foreign owner, they hold just 5% of debt outstanding. Their portfolio of US Treasuries has already decreased, having peaked at about $1.4 trillion in November 2013. Finally, approximately 70% of US debt is held by domestic borrowers, who have no interest in seeing our bond market and our currency come under pressure (see below).

We continue to believe that the US and China will solve for trade before the year is out.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a registered investment advisor.

Chart source: US Treasury

Tagged: Tim Holland, weekly wire, US/China trade, US/China debt