CHINA POWER MOVE?

This hasn’t hit the news cycle yet, and maybe never will, but China made a geo-political power move against the US this week that could prove to be a big deal down the road…

Long story short, China sold $2B in US bonds in Saudi Arabia.?

What Does This Mean?

Let’s step back and see what this means…

A country sells bonds to raise money.? For example, the US sells treasury bonds – which are just debt instruments – to raise money to run the government.? Anyone who buys a US Treasury bond does so with US dollars and every month they get paid interest in US dollars.

Normally, when a country sells bonds, it does it in its own currency.? If China needs to raise money to run the country, they would typically sell Chinese bonds that are paid for in Renminbi (the Chinese currency) and pay interest in Renminbi.

But, this week, China decided to sell bonds in US dollars instead.? Bonds that would be purchased in US dollars and that would pay interest in US dollars.

More interesting, China decided to sell these bonds in Saudi Arabia, an economic friendly environment.? Normally, bonds sales like this tend to take place in big financial hubs like New York or London.?

Why Saudi Arabia?

It’s only speculation, but given that Saudi Arabia is the heart of the global petrodollar system – which ties oil trade to the U.S. dollar – it appears that China is sending a clear signal: it’s ready to play a bigger role in managing global currency, even in places that have historically relied on the US for that purpose.

How Did It Play Out?

There were two surprising – and potentially concerning, from a US standpoint – outcomes from this bond sale:

1. Demand for these bonds were 20 times more than what was available.? China sold $2B in US bonds, but demand was closer to $40B.? There was a big appetite for Saudi Arabia to buy US bonds from a country other than the US!
2. More surprising, China got almost the same low interest rate as the US government selling the same bonds.? In other words, Saudi Arabia didn’t consider this Chinese bond sale to be any more risky than buying treasury bonds from the US government!

Why Should We Care?

There are two obvious risks here:

First, China’s move could shake up how the world transacts currency. If China starts selling more US dollar bonds (maybe tens or hundreds of billions) countries like Saudi Arabia might buy from China instead of the U.S. ?

This would give China more control over how dollars flow around the world and make it harder for the U.S. to borrow money cheaply.

Worse, selling US bonds means that China is stocking up on US dollars (since that is what is being used to buy these bonds).? What might China do with their stockpile of US dollars?

Well, China works closely with many emerging economies around the world that owe money to the US.? Normally, this is paid through trade with the US, providing the US leverage over these countries economically.?

China could step in, pay off the the debts of these countries to the US, and ask to be repaid in its own currency or in trade.? For example, China could offer to pay off some or all of the debt Pakistan owes to the US, in return for trade credits or something else of value from Pakistan.?

At scale, this would reduce the reliance these other countries have on the US, thereby reducing economic leverage that the US has around the world, as well as reducing dollar liquidity and flow.

Long story short, this puts the US at both economic risk and trade risk.

What Can We Do?

There aren’t too many good options to keep China (or any other country) from doing this.

The US could impart sanctions against China, but that risks leading to a larger-scale economic war and could push more countries away from the US dollar.

The US could raise interest rates, making bonds issued by the US more attractive than Chinese-based US bonds.? But higher interest rates has its own risks.

The US could refuse to provide dollar liquidity to the Chinese government (not selling them any more bonds, reducing trade, etc), but that would simply hurt the US’s economic standing on the world stage.

?

The Takeaway

Perhaps China is just borrowing money and doing so in a unorthodox way.? But, it’s possible that China is sending a message to the US that they have currency leverage they could use if we decide to pressure them economically.

?