Treasury Bonds: Why China's 'Nuclear Option' Isn't So Scary

Chinese flagChina's holdings of U.S. Treasury bonds are so huge that they constitute a financial "weapon of mass destruction." At least, that's how the story goes, which is why the prospect of Beijing dumping all its Treasurys in one fell swoop is called China's "nuclear option."

In this view, the sudden dumping of China's $850 billion in U.S. Treasurys would disrupt the bond market, sending the U.S. economy into a tailspin as the U.S. dollar crashes in value and yields rise.

But a closer look at the data and some recent trends suggest the power of this feared "nuclear option" is overrated.

If we brush aside the hype and political posturing, we find that $850 billion really isn't that big a number: It's about 10% of the total dollar value of outstanding Treasury bonds. Of that $8.6 trillion in outstanding bonds, roughly half are owned by foreign central banks and private investors.

The Fed Can Absorb China's Holdings

China's holdings shrink even further when placed in the context of the U.S. Federal Reserve's bond holdings. For instance, in 2009 the Fed purchased $1 trillion in mortgage-related securities to keep mortgages available and home loan rates low. The Fed currently owns $1.086 trillion in mortgage-backed securities, and $808 billion in U.S. Treasurys.

Could the Fed soak up China's $846 billion stake of U.S. Treasury if China were to dump its entire holdings? It's certainly within the Fed's power to do so. It can purchase whatever assets it chooses. Were China to exercise its "nuclear option," the Fed balance sheet would have to expand from $2.3 trillion to $3.1 trillion to absorb the entirety of China's holdings.

While this is hardly a trivial expansion, note that the Fed's purchase of $1 trillion in mortgage-backed assets didn't disrupt the U.S. or global credit markets. History simply doesn't support the claim that such an expansion of the Fed's balance sheet would trigger financial mayhem.

While China Has Sold, Americans Have Bought

While the size of China's holdings of T-bonds has been in the news for years, another trend has gotten much less coverage: Americans have been buying U.S. Treasurys. If we look at Table L.10 "Assets and Liabilities of the Personal Sector" in the Federal Reserve's Flow of Funds report, we see that the amount of Treasury bonds owned by U.S. households shot up from $112 billion in 2008 to $928 billion in 2010. If nonprofit organizations are included, the total rises to $1.06 trillion.

U.S. companies and pension funds (public and private) also own substantial quantities of U.S. Treasury debt:
  • Insurance firms, savings banks and credit unions hold $270 billion
  • private pensions hold $407 billion
  • Federal, state, and local governnent pensions/retirement funds hold $300 billion
  • State and local governments hold $512 billion

In addition, commercial banks in the U.S. own $1.6 trillion in Treasury-issued securities.

According to the Investment Company Institute, American households continue to put their cash to work in bond funds, which have attracted $620 billion since the start of 2009 and $87 billion in the third quarter alone.

Meanwhile, China's holdings have slipped from $940 billion last July to $846 billion in July of 2010 (the last month for which data are available).

All this suggests that the home-grown appetite for U.S. Treasury is robust enough to absorb China's entire stake without major disruption to the bond market. The Fed's power to expand its balance sheet at will gives it the power to buy whatever securities it deems necessary to maintain financial stability.

At less than 10% of the outstanding Treasury debt, China's holdings simply aren't big enough to warrant the frightful "nuclear option" moniker.

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Robert & Lisa

Make our day China. Dump our treasuries and see how much you'd get for them... There is a way to save our country but it requires drastic means. 1st thing is to never vote for a "liberal" again.

October 05 2010 at 7:41 AM Report abuse +1 rate up rate down Reply

Yes, the fed CAN purchase these bonds. But, the question is what are they purchasing the bonds or for that matter the toxic mortgages with? They are creating money ad nilo to purchase it with. This of course debases the dollar holdings of everyone. When you do that too much or too rapidly,people worldwide may lose confidence in the US currency. After all the whole fiat money system is built on faith and not much else. When that faith is lost then nobody will want to give you what they have in trade for dollars whether it is oil or other valuable commodities. We saw how fast things can change in 2008. This so called recovery has been fueled by government spending of borrowed money to elevate the GDP. A so called jobless recovery is no recovery at all, it is only borrowing to juice up the numbers. We are in the "perfect storm" financially with only painful ways out, but no leaders willing to face what they know needs to be done- massive spending cuts.

October 04 2010 at 9:32 PM Report abuse rate up rate down Reply

This story reminds me of the analysts who tried to downplay the impact of the subprime mortgage crisis when it started. They argued that subprime mortgages were only a small percentage of the mortgage market. We all know how that turned out.

October 04 2010 at 9:17 PM Report abuse rate up rate down Reply

If the FEDS can handle the debt then why did we issue the bonds in the first place??When inflation rears it ugly head and its going to! Make no mistake about that statement we should call in as mush of those bonds as we can.

October 04 2010 at 8:23 PM Report abuse +1 rate up rate down Reply

Our debt is their treasure. We lose our ability to pay interest they lose their treasure to infalted worthless dollars.

October 04 2010 at 1:32 PM Report abuse +3 rate up rate down Reply
1 reply to ajgorm's comment

inflated worthless dollars

October 04 2010 at 1:33 PM Report abuse rate up rate down Reply

The Fed is out of control like the politicians in D.C. American tax payers have been pushed aside by the ruling elite!

October 04 2010 at 1:16 PM Report abuse +4 rate up rate down Reply

I don't buy this arguement for a minute. This articles makes out our debt and who holds it not a big deal. I feel it is a very big deal. We need to get out of debt period, not be sugar coating it. How much more vulnerable do these people want us to become? I don't want any country or debt holder to have any control over our future as a country.Just look at the recent problems in Europe and its effects on the markets.

October 04 2010 at 12:34 PM Report abuse +4 rate up rate down Reply
2 replies to Larry's comment

Good point. They have our economy in their pocket . We were sold out essentially to pay for the war and Pork and greed. The only way to describe these times we are going through is CHAOTIC.

October 04 2010 at 12:57 PM Report abuse +5 rate up rate down Reply

its already a big deal. Last time we needed the Chinese to buy our debt (lend us trillions) we ceded the island of Taiwan to them...even though we have a treaty to defend Taiwan against the Chinese. This is NOT public knowledge, but high placed friends assure me that this is exactly what happend during our 'financial' crisis. Plus, China now makes 90% of rare earth materials. We used to make ALL of it. This stuff is used for laser guided missles and bombs. OUR DEBT IS A BIG DEAL, AND VERY DANGEROUS.

October 04 2010 at 2:22 PM Report abuse +3 rate up rate down Reply

As far as the elections go we have discovered that the same people running for office are the same ones that profited off of the melting of the economy. Bid internet businesses to home mortgages these rich are now billionaires with our money. They stole it . Wake Up ! This is why we should really end this practice our government has become so attached to.

October 04 2010 at 12:26 PM Report abuse +3 rate up rate down Reply
1 reply to ajgorm's comment

We have billionaire big shots that stole America running for office asking us to trust them. BILLIONAIRES with our money as we suffer and they are now running for office . HELLO !

October 04 2010 at 12:28 PM Report abuse +3 rate up rate down Reply

Consumerism is hard at work. AMERICA is what makes it work the Global economy that IS. When we go through this kind of economic torture , Obamanists must realize that bigger government with unlimited retirment while soccializing our health options , out sourcing our jobs ,results in BS.. Global growth will not continue without America , as much as they would like it to. Why , because Americas economy is # 1 and we put this global economy into third gear.Sinking us is the worse case scenario. Socialist idealism for Americas ex communists will be their demise not ours. Capitalism will return. So we hang on to what we can , conserve and stay out of debt. Round two is on the way how long can we all hold out is anyones guess.

October 04 2010 at 12:23 PM Report abuse -1 rate up rate down Reply
1 reply to ajgorm's comment

Conserve , dont spend unless you must. If you paid cash for everything then you may ride it out. If you can short sell everyone else and make money off of other peoples misery go for it.

October 04 2010 at 12:30 PM Report abuse +1 rate up rate down Reply

amazing. we are about $ 13 trillion in debt now. if china decided to dump our treasury notes, which in actuality would be bad for everyone, how would we cover an additional $ 846 billion? just where would the money from?

October 04 2010 at 12:00 PM Report abuse rate up rate down Reply
1 reply to renaldo1949's comment

CORRECTION: The USA currently owes about 18 Trillion. Using tricky accounting methods, the pols and the gov't make it appear less. Unbias think tanks use the 18 trillion dollar figure. Soon, all of our taxes will go to pay interest to the Chinese and Japanese. Nice deal if you can get it.

October 04 2010 at 2:25 PM Report abuse rate up rate down Reply