I was listening to an interview with David Harvey and he mentioned that if Russia and China were to sell the debt owed to them by the US, the US economy would take a serious dive. How would they sell the debt and why would that impact the US economy so negatively?
It wouldn't "ruin the US economy". The US (the country as a whole, not the government) bought goods and services from rest of the world by selling them IOUs. So far, the world has been content to let the US roll over these obligations. If the world decided that they wanted to trade these IOUs for goods and services, the US would have to start running current account surpluses and shipping goods abroad to pay for its past current account deficits. These surpluses have to come from somewhere, and they would result in less consumption and less investment in the US economy.
Of course, an economy can't borrow its way in global capital markets forever - the US does eventually have to ship some stuff over to China in exchange for all of the stuff that China shipped over to the US in exchange for (electronic) green pieces of paper. If China decides to unilaterally impose capital controls and stop lending goods to the US, then this hurts both China and the US - the reason capital in China was flowing to the US is that it could get higher returns there. (The functioning of domestic capital markets in China has become a lot better over the past decade, which is why China can now allocate its savings to productive uses domestically instead of lending large amounts of it to foreign countries.)
What some people are specifically afraid about ties into the USD's status as the international reserve currency - the Chinese government and central bank own plenty of US government debt as part of their foreign exchange reserves, and if they want to redeem this debt in exchange for goods and not roll it over, the scenario I mentioned above comes to pass. This seems to me like a grossly exaggerated concern at a time when global real interest rates are quite low. If China wanted to sell its US government bonds and the US had no intention of stopping the rollover process, returns would rise until the market for US external debt cleared, and there's no reason to think that the return response would be large given the low level of global real interest rates. The US (as a country) would have to pay more interest on its debt outstanding, which isn't great, but it's not a disaster of a scale that would "ruin the US economy".
The fear is that higher interest rates would damage the economy. The problem with that worry is that the Federal Reserve could buy bonds itself, to cancel out the foreign selling.
The hidden assumption is that this selling would have to be very rapid. If the foreign reserves managers liquidated their Treasury holdings over five years (for example), the selling would be easily absorbed by other bond market particpants, and nothing much would happen. So, we have to imagine concentrated selling over a span like a week, and the foreign reserves manager is for some reason unconcerned about the price (yield) it sells at.
The question asks: how would they sell? That is the real issue. It is very difficult to see how such sales would represent the national interest of those countries.
If the foreign central bank sells their Treasury bonds, they end up with US dollar cash. They need to do something with that cash. What can they do with the US cash?
- They could buy risk assets (equities, real estate) in the United States. However, countries generally do not want to buy too large positions in risky assets with their foreign currency reserves, and they would face questioning by the US government if they tried. In any event, US risk asset prices would rise, and everyone in the business press would happy, not panicking. Not a plausible option.
- They could buy commodities (or goods). This is equivalent to blowing all their foreign currency reserves to buy imports. If there was a global scramble to buy commodities, such an outcome is possible. However, to do this all at once would be expensive. They would more likely want to spread purchases out over time, so that they do not drive up the price of whatever they are buying. (Furthermore, if they buy oil, the dollars would go to oil producers, who would likely reinvest back into dollars.)
- They could buy other foreign currencies (third party countries). The problem is that few countries have the capacity to absorb a huge wave of inflows, and their currency would become very strong versus the US dollar. (The euro is the only plausible candidate, and most foreign reserves managers already own a lot of euros.) The involved foreign country could get mad, and freeze the assets of the foreign central bank that is moving into their currency. Countries diversify their foreign currency reserves, but try to avoid causing disruptions.
- It is possible that entities in the private sector want to sell their local currency, and buy US dollars. For example, we see wuch behaviour during financial crises. The foreign reserve manager would lean against this, selling US dollars to buy back their local currency. This effectively creates a shift between the reserves portfolio (which sells Treasurys) and the private sector portfolio (which is buying US dollar assets), and the net effect on the Treasury market is ambiguous. However, the usual response to a financial crisis in the Treasury market is for yields to fall (e.g., LTCM Crisis, Financial Crisis).
- If they buy their own currency, and the are no corresponding capital outflows, their currency would get extremely strong, and/or their trade balance would have to shift into a deficit. If they buy their currency, someone has to sell. This counter-acts the reason why they have US dollars in the first place - to keep their currency cheap, to develop their export sector. (For example, see the discussion of the “Bretton Woods II” system - link to NBER paper by Dooley, Folkerts-Landau, and Garber.
In summary, it might be possible to find a scenario where such sales make sense, but they probably require something else to go wrong for the United States. Something has to cause foreigners to want to dump their dollar holdings, without worrying about their own trade position.