China meddling with a U.S. drone in the South China Sea has U.S. President-elect Donald Trump and fellow hawks seething. Yet as they fret about Beijing’s military ambitions, they should be encouraged by its drawdown in the financial theater.
Beijing is selling its vast U.S. Treasuries holdings at a blistering rate — more than $41 billion in October alone. The sales are aimed at slowing the yuan’s declines, a trend sure to irk Trump and panic investors worried China might lose control. Emergency liquidity injections are growing in size as banks estimate outflows may have topped $1 trillion since late 2015.
There’s a silver lining in China’s debt drawdown: America’s main rival is no longer its main banker. Japan just replaced China as the biggest holder of Treasuries in ways that matter as much in geopolitical terms as financial ones.
For years now, influential economists like ex-Treasury staffer Brad Setser warned that China holding the most U.S. debt is a national security threat. When push came to shove, Beijing could inflict pain by dumping dollars. While the fallout in world markets would slam China, too, it would shake the biggest economy more as bond yields skyrocket and stocks plunged. As other dollar-laden central banks and big-money investors piled on, credit downgrades and recession would soon follow.
Japan, by contrast, is as a good a friend as Washington has in Asia. So keen is Prime Minister Shinzo Abe to maintain the bond that he scrambled to Trump Tower in New York for an audience with the next U.S. leader. Tokyo becoming Washington’s key banker reduces Beijing’s leverage and offers Abenomics a second wind. The more U.S. Treasuries Abe’s government amasses, the more the yen softens to boost exports. The U.S. gets a sense of comfort. The bond hoarder you trust, after all, is preferable to one you don’t.
Chinese officials have at times hinted at using that leverage. In 2011, for example, the state-run People’s Daily argued that “now is the time for China to use its financial weapon to teach the U.S. a lesson” about its cozy relationship with Taiwan. It’s no coincidence that China’s drone seizure came two weeks after Trump’s brazen phone call with Taiwanese President Tsai Ing-wen.
Japan was America’s main bond customer for decades. That changed in 2008, as Beijing’s need to mop up excess liquidity and control the currency exceeded Tokyo’s. And it led to some weird political dynamics, including Hillary Clinton’s first trip to Beijing as secretary of state in early 2009. She shelved talking points about censorship and human rights in favor of arguments that “our economies are so intertwined” that it’d be troublesome if Washington couldn’t manage its deficit spending. “We are truly going to rise or fall together,” Clinton said at the time. “By continuing to support American Treasury instruments, the Chinese are recognizing” that codependence.
That same year, Clinton summed up her unlikely role as bond-saleswoman in a meeting with then-Australian Prime Minister Kevin Rudd. “How,” she asked, “do you deal toughly with your banker?” It’s a question that the Trump administration might not have to ask if Tokyo’s increasing banker role relegates Beijing to second fiddle.
Japan now holds $1.13 trillion of Treasuries to China’s $1.12 trillion. Together, they account for more than 37 percent of Washington’s foreign debt holdings.
The U.S. may always be vulnerable to political intrigue surrounding debt. In 1997, then-Prime Minister Ryutaro Hashimoto savaged markets by admitting that “several times in the past, we have been tempted to sell large lots of U.S. Treasuries.” One such moment came amid tense auto-industry negotiations. Even so, Japan increasing its dollar hoard relative to China could give the U.S. more latitude to play hardball with Beijing.
Japan might indeed play ball to endear itself to the Trump White House, removing a major risk factor. It would be a politically acceptable way for Abe to devalue the yen with the blessing of a president who has pledged to label Beijing a currency manipulator. As China’s military ambitions rise, territorial disputes boil over and North Korea’s provocations increase, Tokyo will be loath to alienate Trump’s team.
In 2012, the U.S. took the unprecedented step of allowing China to buy debt straight from the Treasury Department, bypassing Wall Street dealers. Why not give Japan that honor instead to encourage bigger purchases? Also, Abe’s efforts to revive Japanese growth and deal with an aging population mean increased borrowing. Trump’s team could devise a cooperative arrangement where the U.S. buys Japanese government bonds.
Getting tough on China would be a lot easier if Trump didn’t have to worry about blackmail and power plays. His White House should strive to strengthen financial ties with America’s friends in Tokyo.
Based in Tokyo, William Pesek is executive editor of Barron’s Asia and writes on Asian economics, politics and markets. www.barronsasia.com
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