China has 1.2 trillion dollars worth of us treasuries. Why would it be a problem for them to get rid of all of them? Why would that destabilize the US economy?
It would increase the total supply of US treasuries available at any point in time, which would require a higher interest rate for the market to clear. Higher interest rates would increase the cost of capital in the US economy, which in most conditions will reduce investment.
However, higher supply would also decrease the exchange rate of the USD, which could be beneficial for exports (which needs to be considered in a context of higher cost of consumer imports and higher cost of production inputs).
"Dumping" would be fine as a descriptive word for many informal contexts, but "dumping" has specific meaning in an international legal context, such as in the WTO, and so regarding the specific question of what it would mean to unload large volumes of US treasuries at the same time, e.g. for the purpose of negatively impacting the US economy, "dumping" would not be the correct term.
It should also be mentioned that China would immediately lose significant financial assets if the 1.2 trillion in treasuries were to lose 100 billion or 200 billion dollars in equivalent value. Considering the relatively large volume of credit extended in the Chinese economy relative to financial assets, this implies a relatively major economic cost to China if it were to make such a move. On the matter of strategic reasons to hold large volumes of US treasuries, the face value argument of the Chinese government is legitimate, if not the complete story: What else should they be holding if not US treasuries?
If China starts dumping u.s. currencies it simply raises the yield of bonds. It's happened before and is simply part of bond yield fluctuation.
Normally when an institution owns a significant percent of a security and decides to try and reposition itself, it begins to sell the security preferably at some percentage of the daily volume or at a rate that the existing market makers can sustain a given price.
The way Treasuries work are that they are for 100 dollars each and they pay periodic coupons which are interest. So a bonds flat value is determined as 100 plus all the coupon payments it will pay yet.
If investments are typically earning a lot then under normal circumstances because you have to wait to collect the coupon payments, and to get the 100 back at maturity, (up to 30 years) the bond may sell for under 100 or at discount. So if you bought the bond for 90 dollars you get 10 plus all coupons as yield on it, giving the yield. Today's yields range from 2.7 to 3 percent roughly which is the same even though some bonds are discounted, some premium and have different coupons depending on issuance.
Binds are issued at auctions by fed, to primary banks. Bonds are then sold on secondary markets where they very in characteristics but sell and buy at a given yield.
If China floods market the bond yield will go up. This is because there aren't enough buyers to sustain given yield, so 100 dollar bond will have to sell for less or at a discount. This means if you buy the bond for under less you get more if you wait for it to mature, thus the yield goes up.
As far as I'm aware the sale and demand for bonds on the secondary markets are the primary factor in determining yield on bonds. If the yield is driven up on the secondary then when the fed issues new bonds they will bid higher coupons because they could otherwise buy more competitive bonds on secondary than at auction.
Now considering that as far as I'm aware of the bond coupon is the only net faucet of m0 or newly minted currency. It would take up to 30 years for the new credits to be realized however it would have a net result of adding m0 or clean money to the economy mitigating the reliance on m2 which is currency generated from m0 but by banks in the form of loans and tied to interest.
Now considering that banks can not know the deposited, loan terms of everyone else, there is nothing to insure that there is even enough free currency available to pay all outstanding loans and interest, thus defaults and bankruptcy could be simply necessary for it all to account. Additional m0 could lower default rate, and have positive benefits.
Now considering that China and Japan have large supply of m0 generating bonds while U.S. uses much more costly and difficult m2, it seems to me this would not be likely course of events that bonds are dumped. But this last half I admit is a bit speculative.
Speaking as someone who has dealt with SAFE (China's State Administration of Foreign Exchange) I can confirm that they are extremely market savvy when it comes to market execution. They employ strategies such as political dealer influence, and timed volume execution to maximise their investments.
A "dumping" of US treasuries, i.e. selling them excessively, would easily be recognised by dealers as being different to their modus operandi. The more dealers SAFE used, the higher the risk of the information leaking, and it is probably a reasonably high risk in any case, but more dealers provides access to more liquidity so this would be an optimisation consideration. Even greater excessive selling would create a panic and a completely destabilising environment since the amount of influence China could exert is significant.
Since US treasuries and the cash dollar effectively underpin the entire system of leverage and collateral in finance, when US treasuries are shunned due to declining values (higher yields) and client margins start going up every market would become much more irrational and incredibly more volatile since leveraged positions would have to be liquidated. As a feedback loop more volatility forces higher margins and more irrational stop-loss triggers. In non-linear dynamics this represents movement away from one equilibrium in a chaotic manner to some other equilibrium or worse no equilibrium - just complete destabilisation and financial collapse. It is also completely possible that such an action, which Chinese investment mangers are certainly capable of knowing the consequences of, would be considered a hostile act by the US government and further conflate the situation via worried investors.
I highly suspect, however that if China were ever to engage in such a policy it would not be on a whim. I can almost guarantee that the process would be carefully planned to last years. I would suggest that the optimum way of China reducing their exposure would be to use the process of holding bonds to maturity rather than direct selling in the secondary market, since there is no dealer required. To accelerate the process of bonds rolling to maturity SAFE would likely sell longer bonds and buy shorter dated ones. This is also helpful since it might disguise their true intent with dealers. China would not have to sell their entire holding to have significant impact, either, probably just a fraction. As an example China could slowly engineer their portfolio so that they amass many holding in a particular sector, eg 1-4 years and then over that period of time do not reinvest any of their maturities and sell their dollars as they came due.
As for the exchange rate if China holds a bond to maturity and is repaid in dollars it then has two options; buys more US bonds (!) as a store of asset value (SAFE cannot simply deposit cash US dollars in a bank like you and I) or sell the USD for another currency. This process creates a supply a dollars and so the dollar would weaken, again enhancing the destabilising feedback loop.
The power of a currency comes from its usage and popularity. The dollar is strong and powerful currency because countries like China hold their state reserves in dollars. By following my statement previously that the power comes from popularity and usage, the problems and downfalls for a currency also come from its abandoning or as you would say - dumping. Abandoning currencies especially from big states that have great economic and influential power like China means distrust in the strength of that currency. In terms of money - distrust means failure of a currency and failure means - currency loses power therefore value. So to put it simply.
Before China dumps the dollar, the exchange rate between the dollar and the euro is (hypotetically) 1 dollar = 1 euro.
After China dumps the dollar, the exchange rate between the dollar and the euro is (hypotetically) 20 dollars = 1 euro.
When you need more units of a currency to buy 1 unit of another one, means that the first one is weak.
I hope this explains something.