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Nuclear Option of China Dumping US Treasuries vs Devaluation: Take II


The alleged "nuclear" option of China dumping treasuries is Much Ado About Nothing. A devaluation is another matter.

On June 22, in Setser vs Rosenberg: China's "Nuclear" Option of Dumping Treasuries, we discussed competing theories on how China might respond to a trade war with the US.

Setser discussed three alternatives, then thoroughly debunked option three.

Imposing new limits on U.S. firms operating in China, and taking actions that limit their sales in China. Apple and GM sell a lot of made-in-China phones and cars that wouldn't be impacted by tariffs.

Weakening China's currency to offset the drag on China's economy from far reaching tariffs. A standard, empirically well-grounded, rule of thumb is that a 10% depreciation (against a basket) raises net exports by about 1.5 percentage points of GDP—which could effectively offset realistic estimates of the economic drag of a trade war on China. This option isn't without risks—it could reignite now contained capital outflows from China, and China might ultimately end up with a bigger-than-initially desired depreciation.

And the perennial threat that China would sell its Treasuries. That could happen as a byproduct of a decision by China to push its currency down—if China signals that it wants a weaker currency, the market would sell yuan for dollars, and controlling the pace of depreciation would require that China sell reserves. Or could happen even if China maintained its current basket peg and shifted its portfolio around—selling Treasury notes for bills, or selling Treasuries and buying (gulp) Bunds (if it can find them—it might end up buying French bonds instead) or JGBs.

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