The US treasury bond crisis

“False story. We would never even entertain a default on any U.S. debt.” These are the words of Kevin Hassett, an American economist, and a former Trump advisor. This very clear and abrupt reaction was issued after a Washington Post article pointed out that some advisors around Donald Trump may intend to cancel the US debt owned by China. The concept of the US defaulting on its debt seems so abstract and improbable, it’s no wonder many economic journals published articles outlining the devastating effect on the world economy should the US default on its debt. While there is no question that a default on federal treasuries is an unprecedented act and by doing so, the US would stir up the waters of the global economy, it is up for debate what impact this would have on the US economy and its position in the macroeconomic world. I believe that the global dynamic would shift significantly if the US were to default on treasuries owned by China, but consequently, after the initial panic passes, the US could be at a more dominant position, looking purely at its place in the economic world.

The US Treasury Bate

In the same way that China is the world’s leading producer of goods, the US is the world’s leading financial asset provider. The status of the US dollar as the reserve currency that gave the US legitimation to generate and monetize debt to the extent that it currently does, and the AAA rating of the US economy, all contributed to the large demand for US treasuries. Buying US debt seems like a very low-risk investment in the world’s largest economy. According to CGTN out of its three trillion dollar holdings, china’s PBOC holds an astonishing third of this in US treasuries. China is not alone, according to the Foreign Reserve and the US Department of Treasures 6.81 trillion USD worth of US treasuries are held by foreign countries. Amongst the largest holders are Japan, China, and the UK where US treasuries contribute a significant portion of total asset holdings.

The Lender and the Lendee Power Balance.

If I were to lend you one dollar, we could easily agree that I am in the position of power in this transaction. You have to pay me back my dollar and I can condition future loans, based on how fast and with what reliability you pay me back my money. However, if I were to lend you all the money I own, the power balance would shift. Now you are in a dominant position because if you decide to not pay me back I lose all my savings. This reflects the situation with countries like China, Japan, and many other that hold a large amount of their assets in US treasuries, The US owes them, they bought of its debt, but because they bought so much of it, a large portion of their savings is now very much dependent on the “goodwill” of the US. The US treasuries were so desired in particular because they were considered safe and reliable. The threats coming from the White House of defaulting on US debt brought panic and justifiably so. All the countries that thought their holding is US treasuries are safe might be at risk of a significant portion of their savings vanishing in front of their eyes.

What if the US defaulted?

Based on the above it seems that if the US was to default on the debt owned by China, the consequences would be unfathomably negative. The US treasuries were bought because they guaranteed stability, if the US was to do this, no one would trust the US treasuries, and hence no one would trust the US dollar and consequently the US itself. Everyone would try to sell out of their holding in US bonds. This would mean a drop in demand for future treasuries issued and hence the US could face a significant issue with funding as no one would look to buy further bonds. Is this indeed what would happen, or could the US climb higher, on the macroeconomic ladder as a consequence of the China-bond default?

Undoubtedly, if the US did cancel its debt owned by China, people would lose trust in the US dollar, and in the US treasuries, the question asked however is what would follow? Logically people will want to sell out of treasuries but who will be buying US treasuries after the US canceled the ones owned by china? The sheer volume of assets generated by the US and the large position of these assets in many countries holdings means that if the US threatened to cancel the debt the second case from my initial “The lender and the lendee power balance” example might come to play. If this scenario plays out China will be impacted severely; and every other country that owns the US, treasuries would now exercise a pro-US attitude, in fears that the US will cancel their debt too. In theory, the US could use this situation to “blackmail” the world economically.

Granted, upon analysing a situation like this we must consider many factors, politically, and even fiscally if we consider the big picture, this would have negative effects on the US in the short term. They will “make” money by debt cancelation but would drastically change how the world views them. Instead of a pro-trade, pro-cooperation approach that drives economic growth, the US would go on an unfriendly offensive, costing it all its economic reputation. While it is exceedingly improbable that the US would ever cancel a treasury bond owned by another country, and while the effects would be negative and the situation that follows very hectic, there is a possibility that on a purely economic level, a treasury bond default from the position that the US is right now, could solidify its place as a dominant force in the world’s economy.

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