Further to the break down of the US-China Trade Truce in early May, both sides raise tariffs against the second batch of import items from the opponent. (NYTimes, 2019) Negotiation may still be engaged though, the prospect of reaching an agreement in the near future does not seem to be bright.
Due to the substantial trade deficits, the amounts of import items to be levied in this second batch are highly asymmetric. When Trump announced raising tariffs on $200 billion worth of Chinese goods, the Chinese counterpart announced raising tariffs only on $60 billion worth of US goods in retaliation. (Reuters, 2019)
However, China got another so-called ‘nuclear weapon’. Since China holds the biggest share (about 17%) of the US Treasuries and the transacted amount since June 2018 shocked the market as shown in Figure 1. It is now worrying about whether China is dumping US Treasuries! Figure 1 shows the recent continuous and substantial drop in China’s holding of US Treasuries from the recent peak of about $1.2t to $1.12t.
Another alternative hypothesis on the substantial drop of China’s holding of US Treasuries is about a Currency War. Since 2008, China has tried hard to keep the USD-RMB exchange rate at or below 7, and there are strong relationships between dumping US Treasuries and the currency strength. As the Trade Truce would likely reduce USD available in China. The so-called dumping of US Treasuries may merely be a reflection of the actual demand and supply of US currency for trading and investment purposes in China, if a stable exchange rate is to be achieved. Figure 2 shows the sudden weakening of RMB and the approach towards the cap at 7 in recent weeks. (Bloomberg, 2019b) It reaches 6.92 at the time when this article is written on May 23.
How to test critically to differentiate the two hypotheses? There have been very few analyses on differentiating the two arguments, even though different parties argued on their chosen hypothesis and tried to convince readers with anecdotes.
The second hypothesis can be directly tested empirically by time series analysis, as both series are market data (exchange rate versus China’s holding of US Treasuries). Yet, the test of the first hypothesis may be intriguing as it is testing about retaliation actions taken by two countries’ leaders. Since their decisions can be irrational and non-economical, and the trade truce is a relatively recent event, thus there cannot be enough data for testing the hypothesis. Bearing in mind that all past data before the trade truce cannot be used to test the first hypothesis. In other words, the ‘dumping hypothesis’ can at best be a reasonable conspiracy hypothesis which cannot be confirmed by empirical evidence, unless the involved politicians come out to tell the public the truth!
Bloomberg (2019a) China Cuts U.S. Treasury Holdings to Lowest Level Since 2017, May 16. https://www.bloomberg.com/news/articles/2019-05-15/china-s-u-s-treasury-holdings-post-first-decline-since-november
Bloomberg (2019b) Trade War May Yet Spur China to Sell Treasuries as Yuan Tumbles, May 15. https://www.bloomberg.com/news/articles/2019-05-14/trade-war-may-yet-spur-china-to-sell-treasuries-as-yuan-sinks
NYTimes (2019) Trump Increases China Tariffs as Trade Deal Hangs in the Balance, May 9. https://www.nytimes.com/2019/05/09/us/politics/china-trade-tariffs.html
Reuters (2019) Factbox: Tariff wars — duties imposed by Trump and U.S. trading partners, May 14. https://www.reuters.com/article/us-usa-trade-tariffs-factbox/factbox-tariff-wars-duties-imposed-by-trump-and-us-trading-partners-idUSKCN1SJ1ZJ