Financial Warfare
China's next big move
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We're back at it again, cracking the code on all this financial stuff. Remember, we're in this together, breaking down the fancy jargon and making this whole money thing make sense. Swing by my Twitter(X) @Lumberhawk- I keep the conversation going there with more insights and real-time updates.
That being said, today we're going to talk about some moves out of the CCP...
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What is the big story?
China seems to be accelerating its efforts to sell off US-dollar denominated assets, with a significant focus on US Treasury bonds. In the past year, China has sold approximately $101.9 billion in US Treasuries, reducing its holdings to $767.4 billion. This is down from a peak of $1.31 trillion in 2013. This illustrates a broader trend where China has been gradually reducing its exposure to US assets, including a substantial $53.3 billion sale of Treasuries and agency bonds in just the first quarter of 2024. Additionally, Chinese investors offloaded a record $42.6 billion in US stocks and bonds in May 2024 alone.
China holds $3.2T in foreign reserves, including significant amounts of US agency bonds, US corporate bonds, Treasury bills, US stocks and equities.
This selling is driven by multiple factors, including a desire to support the Yuan, diversify away from US-dollar assets, and respond to rising geopolitical tensions between the US and China.
These asset sales put upward pressure on US Treasury yields, which could increase borrowing costs for the US government and businesses, potentially slowing economic growth. Moreover, China is diversifying its reserves by significantly increasing its holdings in gold, which now makes up a higher percentage of its reserves than at any time in the last decade (about 5%).
As of Monday, Bloomberg is reporting on a potential $1T “avalanche” of conversions of USD into Yuan in order to strengthen the Yuan by 10%. If this scenario becomes reality, it would be important to monitor the Fed’s signals closely, as their response would be critical to mitigating some of the most severe economic impacts.
Why would China do this?
While dumping US assets would certainly hurt China’s export sector, it might be part of a broader, longer-term strategy that includes reducing reliance on exports and promoting adoption of the Yuan internationally. The move would carry significant risks for China, but if the leadership believes the long-term benefits outweigh the short-term costs, or if they feel compelled to act for strategic or political reasons, they might still pursue this course. Let’s break it down.
Reducing Reliance on Exports: China has been attempting to shift its economic model from being heavily reliant on exports to one more focused on domestic consumption and high-tech industries. Strengthening the yuan could align with a broader strategy to reduce dependence on low-margin export manufacturing and promote higher-value sectors, such as technology, services, and green energy.
Hedging Against US Financial Risks: China holds a large amount of US assets, which ties its financial stability to the health of the US economy and the dollar. If China anticipates significant risks to these assets—such as from a US default, inflation, or financial instability—it might preemptively sell off some holdings. This could be a defensive move as much as an offensive one.
Managing Capital Outflows: If China faces significant capital outflows due to its current real estate market situation, it might need to take action to strengthen the Yuan and stabilize its financial system. However, dumping US assets in a way that destabilizes global markets would be a double-edged sword and could exacerbate those capital outflows, so this would be a risky strategy in the short term if mishandled.
Boosting Domestic Consumption: A stronger Yuan increases the purchasing power of Chinese consumers by making imports cheaper. This could stimulate domestic demand, improve quality of life, and help China’s economy transition toward consumption-driven growth.
De-Dollarization: Dumping US is clearly part of a broader effort to weaken the US dollar's global dominance, which is a tool of US geopolitical power. By reducing its holdings of US assets, China might be aiming to diminish its exposure to the US financial system and promote the Yuan as the next global reserve currency. If successful, this could enhance China’s economic influence globally and reduce its vulnerability to US financial sanctions or pressure.
Global Confidence in US Dollar: Such an event could undermine confidence in the US dollar as the current world’s reserve currency. Countries and investors might start diversifying away from the dollar, leading to long-term shifts in global financial markets. We are already seeing the beginning stages of this shift.
Strategic Signaling: By selling US assets, China could be sending a signal that it is willing to endure short-term economic pain for long-term strategic gains. This could be a way to deter further US economic or military actions by demonstrating China’s readiness to escalate tensions if necessary. With economic allies such as Russia, Iran, South Africa and Brazil, China is leading by example.
Testing US Resolve: China might take such action in a calculated way to test the US response and assess the limits of its economic influence. This could be part of a broader strategy of gradual escalation, rather than a full-blown confrontation. Remember, they have their eye on Taiwan for sure.
What would happen to the US economy?
If China were to rapidly dump $1 trillion worth of US assets to boost the value of the Yuan, the downstream consequences for the US and US markets could be significant. Here are some potential effects: