As US/China relations take a turn for the worse, 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 the chart below – it is a reasonable question and concern.

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

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

We think it’s 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 of US debt they hold just 5% of debt outstanding. Also, their portfolio of US Treasuries has already shrunk, having peaked at $1.4 trillion in November 2013. Finally, 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 the chart below.

We continue to believe 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, US Treasury debt, US/China relations, US/China trade, weekly wire